September 18, 2007
HP-561

Assistant Secretary Ryan Remarks before the SIFMA Asset Managers’ Group

Boston- Good afternoon. Thank you for inviting me to join you. It's great to return to Boston and it's my pleasure to be here.

A Historical Perspective

Massachusetts is rich in history and this city is rightly proud of the many contributions it has made to our nation, including those in the fields of finance and asset management.

Massachusetts lays claim to a fundamental concept that serves as a cornerstone to the asset management industry: prudence in the role of a fiduciary. The Prudent Man Rule was established by a Massachusetts court decision in 1830 in which trustees were directed to "observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested."

The standard has evolved over time, but after almost two centuries, the principle still resonates. The challenge for fiduciaries is not to avoid risks. Rather, prudence dictates that fiduciaries seek to identify, assess and manage risks. Despite more tools and greater experience the responsibility seems to be becoming harder to fulfill.

The asset management industry is constantly evolving. Its growth and development mirrors the interests of the increasingly broad range of investors and their myriad investment objectives. One group of institutional investors has had a large influence on the asset management industry --- pension plans. Their assets are invested on behalf of millions of beneficiaries. These beneficiaries include retirees and workers. Some are firemen and policemen; others include teachers, factory workers and service providers. These beneficiaries entrust their savings and the important job of investing on their behalf to you and your colleagues in the asset management industry. These workers answer the bell every day -- whether it is the one in a firehouse or schoolhouse -- or the one on their alarm clock. Fiduciaries working on their behalf must do the same.

Fiduciaries to pension plans include trustees and asset managers. We continue to witness pension plans, both private and public, diversifying their investment portfolios. In doing so, they are frequently increasing their allocation to alternative investments. These allocations are meant to complement other investments, an increasing number of which utilize more complex and opaque investment strategies and instruments.

In fulfilling their obligations, fiduciaries must appreciate that they represent the first and most important line of defense for the interests of their beneficiaries. No one should suggest that plan trustees or portfolio managers should not take risks – in fact they must take risks in order to generate desired returns. Investors must have the opportunity to succeed, and in doing so they thus also have the freedom to fail.

However, given the characteristics of many of the strategies and securities defining our markets today, fiduciaries must return to some of the fundamentals of investment management. They must seek to excel in risk management as much as return management. Risk management is not some part-time responsibility – it's a fundamental obligation of a fiduciary's duty.

Every investment strategy introduces risks. As fiduciaries acting in your clients' best interests you play an important role in identifying, assessing and managing risks.

We should acknowledge that the risks are many. They range beyond volatility to include valuation, liquidity, credit, operational risk and reputation risk. Many investment strategies and securities today are very complex and opaque. These characteristics create added challenges including valuation and performance calculations.

A decade ago, investors received holdings statements and performance reports from their custodians who simply relied on having actively-traded securities priced off of independent pricing feeds. That is no longer the case. Today, many investment strategies contain illiquid investments. Assets are often priced by complex quantitative models, in many instances built by the asset managers themselves. In the most disconcerting cases, assets were priced to rating where, in just a few weeks, they went from priced to perfection --- to priced to rejection.

Over the years, marketplace behavior has been influenced by the growth and scale of institutional assets, coupled with the obligations required by laws, such as E.R.I.S.A., and prudent fiduciary practices. The presence of institutional investors has influenced many practices ranging from reporting standards to fees. These trends are well-established within the traditional long only asset management space. More recently, we are witnessing how hedge fund managers are evolving in response to institutional investors' demands for more detailed information, higher quality business standards and operational practices, effective compliance and increased transparency.

These efforts help to define market discipline. Policy makers are very supportive of efforts that strengthen market discipline, since such efforts serve to mitigate systemic risk.

Fiduciaries play two critical roles. Besides contributing to market discipline, fiduciaries -- both trustees and asset managers -- play a powerful and important investor protection role. By continuously evaluating and monitoring their investments, they help protect their beneficiaries' financial interests, and either indirectly or directly, their own interests.

Sound practices on the part of fiduciaries are critical to fulfilling their obligations. Fiduciaries have an ongoing responsibility to perform due diligence and must continually ensure that their investment decisions are prudent and conform to sound practices, including diversification. We therefore need to ensure governance and asset management practices are as robust as possible.

As asset managers, you must appreciate that you are a part of a larger group of stakeholders – each with its own role and responsibilities. Besides yourselves, other stakeholders include your clients, as well as your counterparties and creditors, and the regulators.

Early this year, the President's Working Group on Financial Markets (PWG), which is chaired by Treasury Secretary Paulson and includes the Chairmen of the Federal Reserve, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, issued Principles and Guidelines Regarding Private Pools of Capital for these four groups of stakeholders. Speaking with a unified voice, the PWG advocated for stronger market discipline. The PWG did not wish to endorse the status quo and therefore issued a call to action for each group of stakeholders.

The principles and guidelines address a range of issues including the need to ensure that risk management systems are sufficiently robust and sophisticated to identify, analyze and manage the broad array of risks. The principles also focused on the need for clear and meaningful disclosure so that investors can properly evaluate risk, decision making and performance. The PWG noted that qualitative measures should also be a part of any well designed due-diligence process, including information on the formation and structure of vehicles, reporting, administration, audits, and other factors and terms.

The principles and guidelines also focused on the importance of counterparty risk. As asset managers, you have to appreciate that your counterparty lending institutions must understand the risks inherent in your investment strategies and operations. They must determine appropriate credit terms. In doing so, they must assess liquidity risk and operational risk. They also need to be disciplined and independent in quantifying valuations. Furthermore, they need to guard against the risks to their reputation. Prudential regulators closely monitor the lending institutions' management of these risks and assess whether their performance is in line with expectations set out in supervisory guidance.

To deal with these challenges, asset managers must be part of the solution and maintain appropriate policies, procedures, and protocols. While current practices are in place, they must be reviewed, clearly defined, implemented, and continually enhanced. Besides counterparty risk management, asset managers also have a responsibility to continue to strengthen and enhance the processing, clearing, and settlement arrangements for all securities, and in particular OTC derivatives.

The PWG guidelines serve as an excellent foundation. But now is the time to complement the initial effort with secondary efforts. Along these lines, Secretary Paulson recently announced the establishment of two separate yet complementary private sector committees. The first will be comprised of investors and the second of asset managers.

The first task for each group is to develop detailed guidelines that would define "best practices" for their respective communities. These efforts will help strengthen market discipline, mitigate systemic risk, augment regulatory safeguards regarding investor protection, and complement regulatory efforts to enhance market integrity. These guidelines will have as a foundation and be consistent with the broader principles and guidelines comprising the PWG agreement released in February 2007, and will build on existing industry work where possible.

Conclusion

As fiduciaries and leaders within the asset management community, I want to encourage you to answer the call to action. There is much work to do. The bell is ringing, and you must all take the necessary steps to protect your clients and enhance market discipline.

As stakeholders in the asset management industry you must continually uphold and enhance the highest quality standards of excellence. Failure to do so only compromises an industry with deep roots and a proud legacy. As fiduciaries, you must stand for your clients' interests, for as our first Secretary of the Treasury Alexander Hamilton warned, "Those who stand for nothing fall for anything."

It is a privilege to be entrusted with the public's interest and capital. With such a privilege comes responsibility. To achieve our goals we need to recognize that the responsibility is borne by both the private and public sectors. Building upon the efforts to date, all stakeholders must continue to do more. Collectively, we can strengthen the vitality, stability and integrity of the public's investments and our capital markets. The system works when all stakeholders recognize the benefits, mitigate the risks, and choose to participate.

Thank you again for the opportunity to speak here today.