PALM DESERT, CALIF.-"The past 60, 90 days have been the craziest that risk managers have ever faced in their careers, in terms of the national debate over the U.S. debt ceiling, market volatility and a host of other key risks asset managers are now facing," said Joseph A. Carrier, chief risk officer at Legg Mason.

Which is helping put risk management and the work of chief risk officers at the forefront of fund management. Carrier made his remarks at the Investment Company Institute's Tax and Accounting Conference here last week.

The short list of the most critical risks today include:

* The impact on operations and asset values of extreme market volatility

* Liquidity in all types of funds, particularly in light of the European debt crisis

* Money market funds' exposure to low-yielding instruments

* Underperformance of more than half of the equity funds in the marketplace

* The surge in complex new products, such as funds that invest in derivatives or credit default swaps

* The resulting pressures on back-office processing

* Conflicting economic outlooks of various asset management firms

* A strain on overall industry economics, with assets under management down across the board

* The potential assumption of ill-advised instruments as a result of the decline in assets under management

* A heightened regulatory environment

* Cybercrimes and hacking into investors' accounts

"The marketplace has changed. Risk management is now front and center as a top priority for asset managers," said Kristina Davis, a partner with Deloitte & Touche. "CROs, chief compliance officers and other key executives now have an active dialogue with management on risk infrastructure and technology. There is also an increasing focus to make sure that risk management is tied to a firm's structure, and management is even considering what could go wrong with their strategy."

Since the credit crisis of 2008 and the recession, Legg Mason has developed a new approach to risk management where the impossible and the improbable are considered. "The new terminology at our firm is 'managing outcomes.' We are not just history-based, looking out the rearview mirror, but through the windshield," Carrier said. This lesson should have been learned a decade ago, when the terrorists attacked the World Trade Center twin towers and the Pentagon on 9/11/01 by hijacking airliners and slamming into those structures, Carrier said.

"I remember post-9/11, talking to one of our analysts," Carrier recalled. "He wondered how the CIA and the FBI could have failed. Well, the real reason was we had a failure of imagination. We could not conceive that such an event was possible. And it is true that some of the risks we oversee are a matter of life and death, so since then, we try not to have a failure of imagination and consider the realm of every possibility-because so much has changed in the world since the 9/11 attacks and the credit crisis."

Besides considering various business, political, market and economic scenarios that could occur, the next most critical component of a robust risk management system is empowering CROs with a direct line of command into the board and chief executive officers. This allows them to deliver bad news, directly.

At T. Rowe Price, the board's audit committee oversees risk, said Deborah Seidel, business risk manager at T. Rowe Price. In addition, the CRO who reports directly into the CFO and also has a dotted line to the CEO. Further, key individuals sit on a separate risk management committee, including the CFO, chief operating officer, chief compliance officer, head of operations and technology, director of human resources, in additional to all of the international top auditors and CCOs.

Key concerns at T. Rowe Price include governance, anti-money laundering, privacy, derivatives and auditing. "We want to make sure each of these groups has a charter to manage risk," Seidel said. "Both the audit and the risk management committees receive monthly metrics and have a clear escalation path to bring potential problems to the attention of upper management. As well, they help us with firmwide prioritization on risk management."

As CRO of BNY Mellon Investment Management, Brandon Donnellan agreed that the key to doing his job effectively is to be independent and able to deliver bad news. Similarly, BNY Mellon also has a senior risk committee, which is chaired by the CEO. In addition to this, there is both a risk and an audit committee, which Donnellan regularly meets with.

Organizationally, there are three layers of risk management, Donnellan said. First, there are corporate, enterprise-wide risk management policies. Second, each line of business has its own risk management controls. Third, each of the asset management boutiques that BNY Mellon runs has its own risk manager, and each of the boards overseeing the bank's funds regularly address elements of risk.

The approach to risk management is similar at Franklin Templeton, said Debbie Bartel, director of quality assurance, risk & control. Franklin Templeton has a risk, committee, a counterparty risk committee and a complex security review committee-in addition to a business unit that works with the entire portfolio management team to examine investment risk.

These types of enhanced risk management partnerships among senior executives and boards have become more common at investment firms, Davis said. This was borne out in a survey of 131 asset managers that Deloitte recently conducted that found more than 60% have increased risk management reporting to the board or top management, or both-and not just the frequency but also the depth and breadth. Additionally, 40% have risk dashboards that detail areas managers must oversee, and 28% have a risk committee.

"Having this open access directly into the CEO and the board is critical for CROs," Carrier said. "We are not like the optimistic sales guys. We are the bearers of bad news, and as such, we need to be sure we are safe in doing that."

T. Rowe Price has been able to face potential risks squarely in the face because of its strong customer-focused structure, Seidel said. "There is a very open, transparent dialogue in the organization on risk. Our CEO has also made it clear his ownership of risk management is very strong, and has sent a very strong message that risk management is a priority and that he wants to know about potential problems."

Firms have become far better prepared for challenges, as proven by how well asset managers responded to the debt ceiling debate, the European debt crisis and Hurricane Irene, speakers agreed. As Donnellan put it, "We need to take the drama out of risk management. To a great degree, firms have ramped up their risk management oversight. There is a very different feel to it today than there was in 2008."

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