Shedding Light on Non-Financial Risks – a European Survey

Shedding Light on Non-Financial Risks – a European Survey — January 2012

3. The Need for Change in Regulation and Risk Management Practices

retail investor insurance (ICSD): some 32% disagree, and 39% are unsure. Similarly, private insurance is notably raising a lot of uncertainty for respondents. Some 30% disagree (28% agree) that the availability of private insurance against non-financial risks should be required, and as many as 42% of respondents are unsure. While not being consensual, increasing capital requirements is comparatively favoured by respondents (42% of respondents favour this option, against 28% for private insurance), so it may seem inevitable given recent regulatory developments (Waters, 2009). The industry seems to be conscious that under-capitalised asset managers create unknown risks for their investors, and even when they are backed by a parent company, it is not always clear in which circumstances this parent will be obligated to pay (see for instance the failure of Morgan Grenfell, a subsidiary of Deutsche Bank, in 1996). The exposure that depositaries have to their largest sub-custodian can represent several dozen times their capital. So, the implicit reliance on the depositaries’ supposedly large capital reserves for insurance is in practice meaningless, and the notion that depositaries alone should have their own capital should be scrapped: setting capital requirements wards off the risk of an investment firm’s failing to monitor large risks or to inform shareholders and clients of them. For all parties to be held liable for their actions, they must hold capital to give them incentives to manage the risks their decisions contribute to.

regarding non-financial risks (21% are unsure). The burden should not be limited to them, though. Amajority of respondents (65%) agree that greater fiduciary duties should be required of depositaries (14% disagree). Most prominently, 75% agree that a clearer responsibility regime should be instated for depositaries, with monitoring and obligation of means (18% are unsure). There are some variations across countries, naturally. For instance, French respondents are quite in favour of a responsibility of depositaries and against reinforced responsibility of investment managers, but the reverse is true for British respondents — a discrepancy that reflects cultural and historical country regulations. The same significant difference appears for retail insurance (a theme that is also less favoured by the Germany, Austria and Netherlands group). Note that the questions in this section regarding depositaries are more about fiduciary duties, control and obligation of means than about capital protection and restitution. As to how translate this responsibility, on aggregate, neither private nor public insurance are favoured. This may be because it would probably the investment firms that would pay this insurance to complement capital requirements; furthermore, not only is there a reluctance to the ICSD as the proposed solution could lead to adverse selection, but also, in practice, private insurance solutions have not taken off.

Indeed, there are doubts surrounding the appropriateness of a European regime of

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An EDHEC-Risk Institute Publication