Advantage: Navigating Through Eurozone Changes, High-Risk Customers and Troubled Projects

Euro Worries – Not Just for Europe

Michael Talbot | mtalbot@navigant.com | 609.219.8721
Joe Morant | joe.morant@navigant.com | 617.748.8363
Mohammad Ali | moali@navigant.com | 312.583.6914

When NASA announced that its Upper Atmospheric Research Satellite, which launched in 1991, would fall from orbit last November, most people did not rush out to buy insurance. In fact, NASA estimated the odds of an individual being hit by falling debris as one in several trillion.

In the late 1990s, the financial services sector saw the launch of the Euro — and today investment managers wonder whether the Euro will come crashing down, whether they will be hit with the falling debris, and if they can “buy” insurance. Setting aside the broader implications of a complete or partial breakup of the Euro, this article explores some of the challenges likely to fall upon operations and technology departments within investment management firms and the steps that should be taken now to limit risk.

Risk of collapse

The possibility of a complete collapse of the Euro seems almost as unlikely as being struck by a falling satellite; however, the probability that one or more countries may exit the single European currency is not nearly as remote. Coming out of the 2012 World Economic Summit in Davos, Switzerland, Reuters reported that an informal poll of past and present heads of central banks saw a 21 percent risk of the 17-nation single currency breaking up in five years.

By most objective standards, the risk of any change to the Euro should be categorized as medium level and therefore should be subject to careful analysis and contingency planning (Exhibit 1). Yet, in a recent survey of 100 executives from U.S. and European investment management firms, half of those expecting a breakup in 2012 said their firm is not preparing or that they were unaware of any preparations. Of the U.S. survey respondents, no one’s firm is preparing — and the SEC’s requirement that they more clearly define their exposure to European sovereign debt is regarded as an annoyance.

Where do you need falling Euro “insurance”?

If a disaggregation of Euro participants occurs, the operations and technology departments of global investment managers will be faced with fundamental changes to core processing systems to unwind the currency — without the benefit of the almost seven years allotted for implementation. While every firm has its own risk tolerances, Exhibit 2 is an example of a risk assessment based on the relative impact to core systems and the effort to implement changes.

Navigant recommends, at a minimum, addressing all risks with a medium to high impact assessment, represented here in the upper right quadrant (“Risk Impact Assessment”), although prudent planning would suggest a consolidated plan to address all impacts associated with a changing Euro. The upper right quadrant areas are in immediate need of contingency planning. By way of example, we explore below two of the highly impacted areas: Data Management and Client Reporting.

Exhibit 2

Data Management

In the operational risk assessment of any Euro breakup, an investment manager must consider potential impact across all data management processes and evaluate how the firm receives, stores and reports on data. The review should extend beyond operational workflow to the technology infrastructure underpinning it, since any complex practices requiring manual processing could not possibly execute a timely transition. Contrary to early assertions that any breakup is simply a reversal of the changes made in the late 1990s to accommodate the launch of the Euro, there would be no extended lead time in a disaggregation to plan and test for new currencies. Impact will be felt everywhere from investment models to client management activities, and a plan to provide coverage across the entire workflow should by now already be in a developed stage.

A sound plan should also be flexible to accommodate virtually any multi-currency scenario that might arise.

Given the shifting sands in Europe, it is wise to plan for the possibility of a combination of several states, such as Greece, Italy, Spain, Portugal and/or Germany, exiting the single currency. Readiness for “Day 1” — the date on which the first country exits the Euro and re-introduces its legacy currency — must address short-term, immediate issues as well as long-term consequences of the change.

The re-introduction of a new sovereign currency unit, for instance, would require re-denominating assets as part Euro and part new legal currency. Before the dawn of Day 1, investment managers need to know how to handle open trades and how to alter settlement instruction including account number, identification code and place of settlement. Taking a lesson from a complication during adoption of the Euro, wherein the number of decimal places used in conversions differed from one party to the next, conversion methodologies should be approved in conjunction with a data vendor. Further out, systems should be in place to preserve the integrity of return calculations in the split-currency environment, and transactions would need to be restructured to prevent tax triggers and other exposures. For seamless record-keeping, a mechanism may be needed to create a history for any newly reintroduced sovereign currency, since the currency would have had no relevance during the time of the Euro. Without proper planning and execution, incorrect settlement instructions or inconsistencies with the market could result in significant losses.

Client Reporting

The challenge for firms right now is to evolve these internal systems for as-yet-undefined crises while at the same time reassessing outward-facing responsibilities. Following a Euro breakup, data management changes made to support the new currency would streak across a firm’s systems and come to a crash landing on the compliance, client and regulatory reporting functions. Special attention should be paid to client reporting impacts as small errors or delays could cause widespread negative repercussions on client service, confidence and revenue. These scenarios represent just a few of the liabilities visible externally, but they highlight the criticality of early planning and the risks of a poorly executed strategy.

Communication and reporting will be vital at a juncture when every client is looking skyward for falling debris. Transparency will be crucial for sustaining investor confidence and providing evidence that the repositioning of operations and investments is underway. We know from recent experience that investors will be clamoring for information to understand the impact on a portfolio — and will want to move forward with the manager who has a clear strategy for navigating both the pitfalls and the opportunities in a redefined market.

Our advice remains that investment managers need to revisit their approach to client reporting from end to end. While others will be forced to scramble to respond to client needs, placing additional burdens on the operational system and exposing more risk, those with transitional strategies in place will reap benefits in terms of efficiency and, ultimately, client confidence.

Conclusion

Our clients have indicated that European Investment Managers have been strongly advised by the regulators to establish contingency plans in anticipation of one or more countries being forced out of the single-currency monetary union, and stateside firms would clearly be wise to follow suit. The bailout of Greece in mid-February represents a temporary reprieve, but industry leaders remain clear: the Eurozone is on the cusp of significant change, which requires immediate attention.

With the support of experienced strategists, instituting the changes required to limit risk needn’t be complex or daunting. Managing shifts in foreign currencies begins with an assessment of potential impact, an awareness of vulnerabilities within the infrastructure, and the execution of a plan that protects a firm and its clients. Engaging contingencies here and now is the only route by which investment management firms can hope to insure themselves against the damage to be caused by a falling Euro.

Installing the Software to Find Bin Laden and Bernie Madoff

Binsar Marseto | bmarseto@navigant.com | 312.583.5796
Tim Mueller | tmueller@navigant.com | 646.227.4402

Your financial institution decided that it is not a good idea to do business with Osama bin Laden or Bernie Madoff. Your institution is proud to have 10 million customers, and to be growing steadily. How do you find two needles in a haystack?

On the surface, installing software to compare the names of your current and prospective customers against various lists seems simple. However, once you consider the number of customers you have, the number of new accounts opened per day and the need to constantly monitor media news and updates to government sanctions, the task can be daunting. Financial institutions (FIs) turn to technology to help them identify these individuals/entities. At the core of this technology is its ability to screen names from FIs’ customer database and transactions against names from sanction lists, official government lists (e.g. FBI list), politically-exposed persons (PEPs) list, and user-defined lists, and generate matched names as alerts to be adjudicated by the investigation unit. This seemingly simple task of comparing lists and finding matches becomes complex as the FI works to develop an approach that gives it the opportunity to identify customers that represent a risk to the institution, and at the same time minimizes the “false positives” that are not true matches and thus do not represent risk.

This article highlights two of the many considerations that FIs should take into account when employing technology to identify customers on various watchlists.

Consideration #1: Determining which watchlists to screen against

The heart of the issue is that FIs need to realize they do not have the need or the manpower to screen their customers and transactions against every single watchlist out there. Even with enough manpower, screening against all available watchlists will only create excessive false positives. Managing those false positives drains compliance and investigative resources and in turn reduces vigilance. So, how do FIs determine which watchlist to screen against?

1) Some watchlists are considered ‘must-screen’; they are required by the regulators to be used in customer and transaction screening. For example, U.S. regulators mandate that U.S. FIs screen against OFAC’s Specially Designated Nationals list (OFAC-SDN).

2) Other watchlists are ‘nice-to-screen’ and are compiled by independent data providers. FIs have the choice to select which of these watchlists to screen against their customer base.

3) Additional watchlists are in between ‘must-screen’ and ‘nice-to-screen’. Regulators may mandate FIs to screen and perform due diligence on customers of certain categories, but the regulators themselves do not necessarily provide an explicit list. In this case, FIs must formulate a screening policy using a risk-based approach. An example is the mandate for FIs to screen for PEPs. The big data providers, such as Dow Jones and WorldCheck, compile extensive lists of PEPs where the list can further be segmented based on occupation category, country of residence, etc. FIs must be prudent in selecting the segments that are appropriate for their risk-based screening.

The lists that fall under points two and three above are typically very large; therefore, FIs must not only answer the question of which lists to include in screening, but also decide whether or not to treat everyone on these lists the same. Additional questions to answer include:

1) For PEPs, should FIs screen all occupational categories? Should FIs treat an ambassador the same as a former minister of education or a small town mayor?

2) Should FIs screen both foreign and domestic names? If so, how do the FIs define “foreign”? FIs may have three or four countries included in the information of a watchperson; which one should be monitored, or do the FIs monitor them all?

3) What type of screening should apply to relatives and close associates of the watchpersons? Which relationship types are most important?

Proper assessment of the risks is crucial, and careful analysis of how watchlist data providers segment their data is a must. The latter point is important to avoid an overlap in screening, resulting in duplicate alerts to adjudicate–or worse–missing a segment altogether.

For example, the late Saddam Hussein and Muammar Gaddafi are both sanctioned individuals (they are in the OFAC-SDN list), as well as politically-exposed persons. If you screen against both the OFAC-SDN and PEP list, you may get two alerts for every customer that has name-similarity with either Saddam Hussein or Muammar Gaddafi. This may increase the volume of alerts to be processed by your analysis team. Fortunately, a good case management tool that is thoughtfully implemented can perform proper aggregations to enable the investigative personnel to resolve the alerts efficiently.

Consideration #2: Working your math

After picking which watchlists or watchlist segments to use in screening, FIs then need to decide what kind of name similarities should generate an alert to be adjudicated by the investigation unit. At one extreme, FIs may want to adjudicate only exact matches (i.e. name-match that has the same exact spelling). At the other extreme, FIs may want low-level similarities to generate alerts to be adjudicated, e.g. a customer named “Bakr bin Laden” may generate an alert because the name has mere similarity to the terrorist “Osama bin Laden.”

Different technology vendors have different proprietary matching algorithms. Even the same software may offer options to use different matching algorithms for different type of screenings (e.g. sanction screening versus PEP screening). Furthermore, there are matching algorithms which will be able to recognize common nicknames in different cultures. This culture-based algorithm will treat “Bernie” the same as “Bernard,” “Bobby” the same as “Robert,” and “Liz” the same as “Elizabeth.” When selecting a vendor, it is advisable to conduct proof-of-concept sessions among your short-listed vendors to ask probing questions, and to run sample name data and analyze sample alert results. Taking a sample of customer lists will allow FIs to determine if the software is creating more of the desired name matches, and fewer of those matches which are not wanted. FIs can use that approach in both product selection and implementation.

Again, thoughtful assessment of the risks is key. While past regulators might not have observed that some FIs were basing their matching algorithm threshold decisions on the volume of alerts generated, today’s regulators are much more likely to request that FIs present a well-documented, risk-based approach to back up their decision.

The first step is to involve departments within the FI that are responsible for setting policy around customer and transaction screening. These are typically the financial sanctions team, the financial investigation team, and/or the enhanced due diligence team. They will need to define what types of name similarity should generate alerts to be reviewed. They may categorize these name similarity types into must-haves, nice-to-haves, and not-relevant. Among the nice-to-haves, a volume-based decision may be appropriate, but it would not be appropriate among the must-haves.

The second step is to run sample name data that is representative of the FI’s customer and transaction base against the watchlists or watchlist segments selected to use in screening.

The last step is to review the matches generated from that run and decide on the name-similarity threshold (usually expressed in percentage terms) above which alerts should be generated.

The second and third step above may need to be performed in iterations depending on the functionality of the technology solution until the best-fit name-similarity threshold is identified.

Conclusion

The above are just two among many important considerations in implementing a watchlist screening technology solution. Nonetheless, as the article suggests, FIs need to avoid over-reliance on technology and utilize their own professional judgment. The chosen technology solution may generate alerts on the customers Bakr bin Laden and Bernard Madoff, and only through professional judgment and research will FIs know that Bakr bin Laden, while related to Osama bin Laden, is the chairman of a multi-billion dollar Saudi Binladin Group, while Bernard Madoff is a convicted Ponzi-scheme operator also known as Bernie Madoff.

How Navigant Can Help

Regulators across the globe are taking a rigorous approach to the enforcement of anti-money laundering and terrorist financing regulations. Navigant has the capability to assist you to comply with the regulations as well as to protect yourselves further from unnecessary risks.

• We combine a deep understanding of financial services business operations with detailed knowledge of the regulations that impact them
• We have the skills to both react to regulator's actions, and to anticipate their requirements – our consultants come from both industry and the regulators
• We are adept at implementing the operational and technical infrastructure necessary to respond to regulations in an effective and efficient manner

Please contact Tim Mueller and Sal LaScala for more detail on our expertise and how we can help your organization.

Project Gone Astray? How to Get Back on Track

Jordan Kuperschmid | jkuperschmid@navigant.com | 908.347.5610
Rochelle Edens | redens@navigant.com | 312.583.6825
Liz Hydock | ehydock@navigant.com | 908.337.6955         

How a bowl of candy, a stodgy office and a baseball game saved three transformations

Despite a worthy goal and efficient planning, every transformational project has the potential to drift off course. Good governance and strong leadership provide important protections, but even veteran managers oversee only two or three major transformations over the entire course of a career — leaving an organization ill-equipped to identify underlying causes or to plan a workable recovery when a project runs aground.

As independent consultants, by contrast, Navigant specialists have been integral to dozens of successful operational changes and IT transformations. The pairing of experience and objectivity places us in a uniquely valuable position to pinpoint a failing project’s weaknesses, assess their impact, and take corrective action. These are the insights we’ll be sharing here, beginning with a look at the methodology we utilize to check the health of a project.

Health-check methodology

Incorporating routine checks is key to identifying vulnerabilities and may prevent the issues that can threaten a project‘s success. It is not uncommon for troubling symptoms to arise within a year of a project’s initiation or may even get off track at the start.

To provide a meaningful diagnosis of a troubled initiative, the project should be examined like a patient being evaluated by a good physician: with no preconceived notions as to cause and a perspective that allows a comprehensive view. Analysis begins with understanding the project’s defining elements, including a review of the charter, an evaluation of governance structure, and a mapping of communication routes. Tethered to these elements are the features of a project that may reveal fault lines, such as: the resources available, the commitment of senior management, the clear definition of deliverables, and the effectiveness of the system in place for measures and metrics.

As described in our previous Advantage article on Change Management, the interpersonal component of a health-check is not to be underestimated. Gathering accurate, useful insights depends not only on a keen observational eye but on having a talent for building rapport with people. To be credible and effective, the party assessing a project must strike a delicate balance between independence and collaboration.

From the observations of an unbiased eye flow the themes that will point the way to recovery. However, an important step is often overlooked before the findings are prioritized and shaped into an action plan: recommendations should first be vetted by a trusted sponsor and/or an expert on the subject matter. Collaboration, respect, and credibility all merge in this approach.

Leading problems and sample solutions

Transformational projects can stall at any juncture due to a range of external factors, shortcomings in internal processes or technology, cultural barriers, or flaws in leadership. With the benefit of having consulted on more than 50 such projects, Navigant has identified eight leading causes for a project to falter:

» Unclear expectations and responsibilities

» Poor process / lack of controls / lack of discipline to follow the process

» Lack of commitment and follow-through by senior executives

» Lack of skills and expertise

» Poor vendor performance

» Poor requirements

» Poor change management and communication

» Changing strategic environment or no long-term strategy

Acknowledging that any of these issues can cripple a well-intentioned initiative, we’re examining here three problems commonly at the root of troubled projects, and characterizing Navigant’s approach to recovery. These are the shortcomings most frequently cited by Navigant consultants who were asked, for the purposes of this article, to identify the areas historically shown to have the greatest negative impact on failed or failing client projects. Each is presented below alongside characteristic warning signs and a brief description of how Navigant assessed and addressed problematic issues at the core of a client project. Within Sample Treatments, see how a bowl of candy, a stodgy office, and a baseball game helped save three projects gone astray.

1. Unclear expectations and responsibilities

WARNING SIGNS

Lack of responsible/accountable team members; Gaps in skill sets; Deficient business support; Long assessment and design phases yielding minimal results; Frequent and significant surprises; Team turnover or Disengagement

HEALTH CHECK

Clear communication — and well-defined channels of communication — is paramount to good project governance. Once the mission of a project is established, conveying expectations unambiguously, inspirationally, and repeatedly is critical to engaging employees. Understanding project objectives and how they align with the company’s overall strategic goals empowers each team member, whose sense of commitment and responsibility grows under the guidance of an accessible leader. Communication requires a strategy; documented roles and responsibilities must be formally communicated and embedded in the performance management system. As economic, competitive, and regulatory climates change, strategic objectives may require periodic adjustments.

SAMPLE TREATMENT

A bowl of candy, a pack of name stickers, and a flip chart were placed at four geographically disbursed transaction centers. The chart was titled “We want to know how you are feeling” and divided in two: one side with a happy face and the other with a frown face. Staff were asked to vote with the stickers and invited to enjoy some candy. Weekly, photos of all four charts were assembled and displayed. The exercise opened a dialogue that led to people asking one another, “Why are you a frowny face?” It became clear that team members were confused about relative responsibilities, and frustration was building.

A large life insurer had a major software implementation project suffering from delays, rework, team member turnover and budget pressures. Through interaction with the project team members, the core cause was identified as a lack of clearly defined roles and responsibilities at the planning stage. “Borrowed” staff were still reporting into their line supervisors, unwilling to take direction from their temporary project bosses. As a remedy, cross-functional team roles were clarified and a firm timeline was established for deliverables. Ownership and accountability were assigned to each deliverable. Performance measures and reporting lines were enhanced. As the project re-engaged, the responsibilities and accountabilities of each team member were clear.

2. Lack of commitment and follow-through by senior executives

WARNING SIGNS

Poor project visibility and sponsor engagement; Increased divisiveness between leadership and dissenting team members; Dwindling participation at stakeholder status meetings; Perception that the initiative is not a high priority; Lack of timely decisions from sponsors; Fading team morale

HEALTH CHECK

The drivers of project success — budget, communication and morale — emanate from senior leadership. Without leadership support, which includes active engagement and timely decision-making, the purpose and momentum of an initiative is quickly lost.

SAMPLE TREATMENT

A newly indoctrinated team leader felt his office in the formal executive wing was stodgy and lonely. Instead of remaining behind his desk, he regularly roamed the halls, engaging with team members and sitting in their offices to meet. His visibility and engagement reassured the team that leadership cared and that their efforts were appreciated.

Navigant was engaged by a major financial institution to review a project that was months behind schedule and well over budget. An assessment revealed that senior management participated in project initiation but then abdicated the oversight role to a project management team and turned their attention elsewhere. The lack of senior support was proving to be detrimental, as the project managers were working without the authority to make decisions and without the support of stakeholders to be impacted by the change. To re-start the stalled project, an active steering committee of senior executives was implemented and more frequent leader-led town halls were conducted. Team building activities were introduced to encourage senior leadership participation, visibility and support. Team achievements were publicly displayed and celebrated.

3. Poor vendor performance

WARNING SIGNS

Vendor not able to deliver on commitments; Gaps in required functionality over the course of a project; Ambiguous statement of work and service level agreement; Vendor resource turnover

HEALTH CHECK

Working seamlessly with a vendor is vital. Successful integration entails recognizing the vendor as an extension of your organization and, simultaneously, as a separate entity with its own motivations. Navigant may review a client’s due diligence process to determine if a thorough examination of the vendor was successfully conducted and whether it included approvals related to both business and to IT. In addition to an assessment of the vendor project plan and schedule, the SOW (statement of work) and SLA (service level agreement) are reviewed for ambiguities that could be at the root of delays or other trouble. Any problems identified are presented to senior management and may require renegotiations or project adjustments. A formal vendor management plan is the foundation for governing the relationship and achieving the desired results.

SAMPLE TREATMENT

The vendor location was quite distant. Conference calls and emails were the primary means of communication. The teams were taking a long time to finish the forming, storming, norming and performing cycle. The client invested in periodically bringing the entire vendor team out to its site. Meeting days frequently concluded with a social activity, where vendor staff and in-house staff could meet and bond over a baseball game. Soon it became apparent that the client and vendor were fully aligned. The vendor proactively asked for help where they were not strong (PMO and Testing), and the client answered by lending first-rate resources to help close the gap.

Navigant was engaged to correct the course of a project with a key vendor reliance that was falling behind schedule. A review of the team organization reinforced the concept that the vendor was a business partner and critical to the success of the project, also affirmed in this Vendor Management Advantage article. A contract review and interviews revealed the vendor had based estimates on a high-level SOW and that the vendor realized−once entrenched in detailed requirements−that it had over committed. A mitigating approach to split the implementation into two phases was developed. Vendor contracts were updated to reflect the modified schedule.

Closing Thoughts

Don’t allow time to pass without assessing the health of a project. Routine monitoring ensures that a team’s work remains true to stated goals even as the business environment evolves and as interim milestones are achieved. Formal governance structuring and open channels of communication are critical to the well-being of a transformational project from the point of initiation through to successful completion. But when a project does show signs of trouble, it’s critical to identify the causes behind the symptoms and to prescribe the appropriate corrective actions. With the benefit of an informed approach, the trouble a project potentially faces can be foreseen and its impact mitigated — if not eluded altogether.