Model Risk: The backbone of the asset management industry

Model Risk: The backbone of the asset management industry

By Abhisekh Adukia, VP, Model Risk Director, Alliance Bernstein

Can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?

Abhi Adukia is Model Risk Director at AllianceBernstein(AB). In this role, he monitors and manages all aspects of model risk governance activities. Prior to assuming this role in 2013, Abhi was part of AB’s Internal Audit Team focusing on audits of Investment teams and functions across the firm. Prior to joining AB In 2009, Abhi was part of AIG’s Derivatives Accounting Group. Abhi started with Ernst & Young in 2005 within their advisory practice and worked on various projects around external and internal audits across financial sector.

Abhi has a Bachelor in Commerce from Mumbai, India and Masters in Finance from SUNY Buffalo. Abhi is also a CFA charterholder, and has CPA and FRM certifications.

What, for you, are the benefits of attending a conference like Risk Americas and what can attendees expect to learn from your session?

By attending a conference like Risk Americas, attendees can benefit in many ways; learn from peers about current activities or concerns, exchange ideas and develop connections as industry members.

With regards to my session, attendees can get a perspective on model risk for asset managers. When we talk of model risks, typically Banks or Insurance Companies comes to mind. My hope is to share my two cents around what asset managers like us do around model risk and why it is relevant for all stakeholders including regulators, clients and shareholders.

You will be presenting at the upcoming Risk Americas 2019 to discuss Model risk for asset managers. Why is this a key talking point in the industry right now?

Put simply, models are backbone of the asset management industry. Any strategy or product that asset managers run will make use of models in some capacity. With constant innovation in technology (both software and hardware) and unprecedented competition in this industry all asset managers are striving to differentiate themselves by coming up with new ideas or strategies with increased use of models. If models are not calibrated reasonably or models are not operating as intended, there could be significant repercussions to the firm. So, robust model governance is critical, and it does not happen overnight.

A significant commitment is needed at all key levels. Typically, once a model is built and put in production, it becomes difficult to review after the fact. Hence, putting the right checks and balances are important while models are being researched and being developed.

How has the role of asset managers changed over the last few years?

Since the past decade, the asset management industry has been going through a structural shift; partly due to the financial crisis and due to changes and innovation in product offerings through ETFs. Assets managed by asset managers have shifted materially shifted from active to passive, due to poor or inconsistent performance.
As a result, asset managers are facing unprecedented changes in the business model. On one hand, there is immense pressure to demonstrate skills through performance while on the other clients, consultants and financial advisors are expecting fee reductions.

How have model risks changed over the last few years and what has caused these changes?

Role of Models are constantly involving and increasing for asset managers. With technological innovations are at rapid pace, computing technology is available at a much cheaper cost with higher speed. Advanced programming tools (I.e., NLP, ML, AL) are being used to create complex models across various spectrum of investment management processes.

Models provide a base line to investment managers in Interpreting the market conditions, asset class pricing, security pricing, risk return trade-offs, understanding various scenarios around political and macroeconomic events.

With increased dependency on models, model risk increases as well from both theoretical viability and operational effectiveness perspective. It is important to ensure that model is calibrated reasonably by assessing and including key factors and applying thoughtful assumptions; equally important is to ensure that models are operating effectively.

What factors need to be considered when trying to develop best practices for model governance framework?

A well-thought model governance framework needs to demonstrate value add to all participants Including the board, senior management, business units, IT teams. It’s a balancing act that attempts to provide value to the business while ensuring risks around models are mitigated for the firm.

Having said that, the culture of the firm plays a key role in implementing the governance framework. And cultural shift takes time, so it takes some time to full Integrate model risk framework in the firm, especially for asset managers.

How has the expectations of regulators affected model risk management?

While asset managers do not have direct regulations on Model Governance like banks or insurance companies have, regulators express their expectations through enforcement orders and fiduciary guidance. In the past few years, regulators have Imposed penalties and orders several compliance requirements for breach of client trust related to use of models. One of the major and key enforcement orders was for Transamerica that came out in Q3 2018. Through this order, regulators have clearly expressed their expectations around model risk management again. While the sources of risks around models are the same, awareness and respect for model risk management activities has certainly increased internally. Model risk teams and business units are more engaged and proactive in executing work, so this further helps the firm, clients and stakeholders.