Investment firms are often underestimating their liquidity risk by not fully identifying potential vulnerabilities and impacts, while they are also failing to fully embed risk management into their day-to-day operations, according to a report from KPMG UK.
Continuing the Journey, written by partner in investment management David Yim, found there is a significant gap between the regulators' expectations for groups' focus on risk and what they are actually doing.
Yim studied 31 investment firms, excluding banks, managing assets ranging from £5bn to £300bn in Q3 using data from ICAAP submissions - the assessments undertaken by firms to assess the level of capital that adequately supports all relevant current and future risks in their businesses.
How can EIS investors manage risk?
Although Yim noted the developments firms had made this year, he said "it became apparent there is progress to be made in order for risk management to reach its true potential".
He said: "Half of firms that have been visited by the Financial Conduct Authority (FCA) in the past year were told risk governance and culture was the key concern and yet, we still have vastly inconsistent approaches to risk identification and a lack of engagement at the top.
"Risk is being treated by many as a regulatory tick-box exercise and not actually changing company behaviour.
"Too many people still see risk teams as a 'no' function, but in reality having a clear understanding of your risk parameters can help you conduct business efficiently, avoid bumps in the road and seize opportunities."
Liquidity stress tests
The report noted that the FCA released a statement in February this year on good practice in relation to liquidity risk, but said investment firms often "underestimate" their capabilities in this area.
Based on the questionnaires received, 28 firms surveyed have developed an individual liquidity risk framework, but 24% of all BIPRU firms (including discretionary wealth managers) have not performed any liquidity stress tests.
BoE reaffirms commitment to asset manager stress tests
The report said: "There is a growing concern in relation to liquidity risk from the regulator and while the majority of respondents have developed liquidity stress tests, there is still some way to go to ensure that liquidity risk is adequately captured and monitored."
Overall risk management
KPMG also highlighted concerns that while firms appear to be on top of operational risk, there is progress to be made in other areas such as business/strategic risk, credit and counterparty risk, market risk, concentration risk, reputation risk, interest rate risk, pension obligation risk and risk of excessive leverage.
"Risk management is often treated as a separate discipline rather than being embedded into a firm's day-to-day operations.
"The FCA has consistently identified governance and culture around risk management, and the degree to which it is embedded within organisations, as a weakness.
"There is often misalignment between risk appetites and risk management tools, and firms are finding it challenging to assess and develop the right Key Risk Indicators (KRIs)," it said.
