The digitization of investment funds: adapt or resist?

Digital overdependence

A step back is necessary. For several years now, the observation has been clear: innovation and digitization go hand in hand in our economy, whether it is the advent of High Frequency Trading techniques (although little used by investment funds investment), the emergence of FinTechs or the use of crypto-assets, the principle of which is based on computer techniques such as the blockchain or even more simply the sole construction of a portfolio that would integrate sustainable finance criteria and would thus have recourse to databases for analysis.

We have entered an era of digital overdependence, the magnitude of which has increased with the current crisis. So what are the challenges for investment funds in this context?

Adapt or resist?

Without hesitation, asset managers have every interest in adapting and embracing the digitalization trends of the world of which they are a part, for several obvious reasons. First, let’s remember that asset management evolves in an ultra-competitive context. The AMF publishes licensing dynamics each year in its asset management figures, and has shown that for the year 2018, no less than 60 companies obtained a licence, resulting both in a dynamism in the flow of entrepreneurial projects and in the international and European political and economic context: the Paris marketplace having, mainly in the context of Brexit, attracted a significant number of British players. Significant figures that will be amplified by European capital market union initiatives that now place fundraising in a multinational dimension.

An essential asset for innovation

Also, if all the techniques are worthy of interest to stand out in the game, it is especially essential not to lag behind compared to its competitors. Beyond the issues of remote working requiring communication and information exchange technologies, the digitization of “core business” tasks is an essential asset for innovation. For example, what manager can display European ambitions today without having a high-performance CRM (“customer relationship management”) tool? An adapted CRM optimizes the management of the customer relationship allowing a more detailed knowledge of its customers and therefore better targeting for its fundraising and investment opportunities.

Digitization: to make better use of your data?

What if we considered digitalization under a different prism, not as a sudden trend but rather as a tremendous asset that investment funds can take advantage of? Several avenues are to be explored: Big Data should not be a factor of complexity in portfolio management because the available data, if they are well exploited, offer opportunities for developing innovative and varied management strategies. Data is a real gold mine for identifying potential investments in promising sectors.

Without dreaming of artificial intelligence and machine learning algorithms, more accessible situations are part of the daily life of many management companies. At a time when sustainable finance is in the eye of the storm, the cornerstone of the European green deal, investment funds are trying to meet their investors’ expectations in terms of responsible investment without falling into the trap of greenwashing. They are therefore working to integrate into their management process real and quantifiable criteria on environmental, solidarity and governance themes in order to select their portfolio assets. Also, digitalization can potentially accelerate the offer of savings and investment solutions, making a wider choice of strategies and management styles available to investors.

Nevertheless, it is access to reliable data that is a key issue here in order to meet the requirements of regulators or investors. For example, for reliable and timely reporting or analysis, you need data that is integrated, accurate and available. Beyond that, you need the right tools but also the in-house skills to use them correctly and properly interpret the results.

Towards cybersecure digitization

But to have reliable and available data, it must be protected. This is where the IT Operational Resilience Bill (DORA) comes into its own. The quality of the data used and their availability, as well as that of the IT tools, cannot be ensured without a cybersecure digitization strategy. DORA thus plans to create obligations for financial entities. We note in particular the following proposals:

  • risk management: managed by the management body, the risk management function should identify and monitor all sources of risk. It is also indicated that the risk management function should be reviewed once a year and audited by IT auditors;
  • incident reporting: financial entities should provide a process for notifying IT-related incidents to managers, national supervisory authorities and customers in the event of harm to their interests;
  • digital operational resilience tests: it is proposed that the risk management systems be tested regularly via a program of resilience tests according to a proportionate application depending on the financial entities;
  • third-party service providers: financial entities would remain responsible for compliance even when they call on a third party for the outsourcing of activities requiring IT services, and therefore for monitoring service providers, reviewing their selection strategy and third-party risk management, adding clauses to contracts and conducting audits.
  • sharing of information: the text proposes to put in place systems allowing financial entities to communicate with each other regarding information and intelligence on cyber threats.

The draft DORA regulation is part of the desire to guide European financial entities towards greater resilience and confidence by adapting to digital challenges. As a result, the Commission hopes, on the one hand, to increase innovation and competitiveness in Europe and, on the other hand, to better protect consumers of financial services. For the time being, the Commission includes in its proposal a principle of proportionality. This principle states that, although the provisions of the text apply to all financial entities, they must however be adapted to the risks of the entity (size, volume, activities, service providers). However, it is not yet guaranteed that the negotiations within Parliament and the Council validate this principle of proportionality, the trend being even – for the moment – to reinforce the measures in view of the importance of the cyber threat.

Towards responsible digitization

The increase in digitalization, although it benefits from the exponential increase in the processing and memory performance of computer equipment, also rhymes with a growing need for equipment. These require natural resources and energy to build them, but also to operate them. Each e-mail, each request in a search engine corresponds to an energy expenditure. The energy required to load a website with several cookies is impressive. IT is one of the most energy-consuming areas of activity. More than ever, protecting the environment is everyone’s business.

Everyone will therefore have every interest in defining their digitization strategy, remembering that sustainable finance must also rhyme with sustainable IT (“Green IT”). Digitization strategies must take into consideration the real needs of asset management companies and implement good IT sobriety practices in order to responsibly manage their carbon footprint, right from the development of the digitization strategy: “Green IT by Design”.