Product Control White Paper

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This page is proposed by Investance, global business and technology consulting firm driven by market leading knowledge capitalisation and focused on the financial services industry.

Introduction

The Product Control function stands at a new frontier and plays a key role in the ability of banks to assess their positions, their results and their risks:

  • Performance is scrutinised with reference to cost in capital allocation
  • Activities are valued with independent pricing
  • Positions are thoroughly reconciled and audit trail is ascertained

Financial institutions are now questioning the positioning of the Product Control function in their organisation to ensure maximum efficiency and ability to serve business sustainability and market confidence.

The reference model of Product Control functions is the US model: several control functions are placed under a unique authority referred to as Product Control and therefore made very visible. In this model, the Product Control function is reporting to the Finance department to ensure independence versus the business.

European models have parted their control functions and placed them under several authorities, making them less centralised and visible. Some controls are performed by the Risk function, the Middle Office, Back Office and Finance.

Financial institutions are taking the opportunity of the financial crisis and consequent business re-focusing to reassess their Product Control model.

Depending on their size, diversification of activities, processes and procedures, they will opt for the organisation and process that is most secure and business challenging.

The measurement of performance of the activity of financial institutions is scrutinised by many actors with regard to growth perspectives, risk profile, as well as ongoing assessment of strategy.

Considering how they are organised, Product Control functions are more or less efficient in their capacity to adequately measure the performance of the activity and raise alerts

The unified model of Product Control is currently gaining momentum, bringing a holistic perspective on the understanding of activities. Seamless ownership of P/L data capture, processing and analysis is deemed providing good control over operational risk, as well as accuracy and timeliness of reporting.

The fragmented / de-coupled model of Product Control delegates responsibility of P/L control to specialised and independent units, giving emphasis to expertise and segregation of duties.

Organisation of the Product Control function

The unified model vs. de-coupled model

Over the past decade, financial institutions have been experiencing several models to position the Product Control function in their organisation charts.

Finding the right model that balances independence, expertise, and efficiency has proven difficult for many organisations.

Some financial institutions have progressively adapted their historical framework, while others have moved back and forth between each model.

The unified model is placing all the core roles and responsibilities of the Product Control function under a single authority. Depending on the financial institutions, this authority can be the Chief Financial Officer (CFO), Chief Operating Officer (COO) or the Chief Risk Officer (CRO).

The de-coupled model is splitting the core roles and responsibilities of the Product Control function under several authorities.

  • The de-coupling can be due to the will to promote synergies with functions other than Product Control.
    For example, P/L explain can be under the authority of the CRO due to synergies with the monitoring of market risk, while the other core roles and responsibilities of Product Control are under the authority of the CFO.
  • The de-coupling can also be due to the will to promote efficiency considering the existence of several control models or information systems specificities.
    For example, Product Control can be under the authority of the COO for the equity business line and the CFO for the fixed income business line.
  • Another reason for de-coupling can be the will to strongly ensure independence and segregation of duties, especially considering key functions.
    For example, pricing of assets can be under the authority of the CFO, while the other core roles and responsibilities of Product Control are under the authority of the COO.

The global model vs. multi-local model

Considering their size, business organisation and level of integration of their processes and systems, financial institutions can favor a global model or a multi-local model for their Product Control function.

The global model is characterised by three integration elements:

  • The Product Control function is identified up to the group level in the organisation chart,
  • Local Product Control functions are under the authority of the group Product Control function. This can also be combined with matrix reporting to a local Head (such as the CFO for example),
  • The group designs a Product Control framework based on a methodology and processes that have to be used in all branches of the group.

The multi-local model is more open and gives extensive autonomy to local Product Control functions:

  • The Product Control function is not systematically identified at group level,
  • Local Product Control functions are under the authority of a local Head only (the CRO for example),
  • The Product Control framework is based on methodologies and processes that can be specific to each branch of the group.

Although some models are mainly multi-local, harmonisation can be observed in some financial institutions for consolidation purposes. Local referentials are mapped to the group's and aggregated results are reconciled to the group's financial reporting.

When combined to a de-coupled model, some financial institutions can mix the global and multi-local models. For example, independent price verification can be under the authority of the CRO and be global, while control of hedge effectiveness can be under the authority of the CFO and be multi-local.

Conclusion

Financial institutions undoubtedly are promoting the unified and global models as structurally more fit to face the challenges of Product Control in a financial crisis environment:

  • Financial institutions have to secure their reputation, some of which have been hit by serious frauds or losses due to uncontrolled levels of risks. Unified and global models give them the ability to eradicate loopholes between the various control layers through a more holistic monitoring of activities.
  • Refocusing on their core business, financial institutions take the opportunity of group wide restructurings to rationalise all teams including Product Control. Unified and global models are favored as facilitating synergies to improve performance and reduce costs.

However, the unified and global models can be difficult to implement and costly in terms of team size. Restricting them to the core Product Control functionalities can be an option, those bringing most of the expected synergies.

Whatever the Product Control model, its efficiency mainly lies in its conditions of implementation:

  • Intense and transparent communication is necessary to coordinate all the skills involved in Product Control, should they be unified or de-coupled into several authorities.
  • Ability of the Product Control function to influence business decisions and drive change should not raise any doubt.

Indeed, Product Control functions can only be effective in a control prone environment. As an illustration, before the Madoff scandal was revealed, alarms were raised by U.S. lawmakers and fraud investigators for years, but ignored by the SEC.

The effectiveness of Product Control functions lies in a large extent on the support of Executive Management that must be open to red flags and demonstrate the willingness to take appropriate and timely action.