From ODD Findings to Investment Decisions
Two asset management firms can both have significant dependence on a senior operations executive and still present very different operational risks.
At the first, important processes remain concentrated around that individual, succession is informal and deputies have limited authority. At the second, the executive remains influential, but responsibilities are distributed, experienced deputies are established and governance can function effectively without that person.
Both observations might reasonably be described as key-person dependency. The label tells the investor surprisingly little about what to do next.
The important question is what the dependency means in the context of the asset management organisation: how authority works, what happens in the individual's absence, which mitigants are credible and what exposure remains. This is why ODD findings should not behave like predetermined investment rules. Similar observations can produce quite different conclusions once the underlying operating model is understood.
“ODD becomes useful when it moves beyond identifying what is imperfect and forms a view on what that imperfection actually leaves the investor exposed to.”
Start with what remains
Asset managers are real organisations. They depend on people and external providers, operate imperfect processes and make sensible compromises between control, efficiency and scale.
Simply identifying those characteristics adds relatively little decision value.
A critical outsourced relationship is a good example. The dependency may be obvious. The more important work is understanding what the manager has built around it. Does somebody clearly own the relationship? Does the organisation retain enough expertise to challenge the provider? Is service quality monitored? Could the activity realistically be transferred if the relationship failed?
The relevant conclusion is the residual risk after those mitigants have been considered.
This also explains why finding counts are a poor measure of operational quality. Six contained observations with clear ownership and strong mitigants can present an easier delegation decision than one poorly understood weakness whose consequences remain uncertain.
ODD becomes useful when it moves beyond identifying what is imperfect and forms a view on what that imperfection actually leaves the investor exposed to.
Management's response is part of the evidence
The underlying weakness is not always the only thing worth observing.
How an organisation responds when something uncomfortable is identified can reveal a great deal about the organisation itself and the nature of the relationship an investor will step into.
A manager that understands the issue, explains it openly, identifies who owns it and responds proportionately presents a different governance picture from one that minimises the same weakness or struggles to explain who is responsible.
That does not make a material control failure disappear. Nor should a co-operative management team receive an easier risk assessment simply for engaging well with the review.
But response behaviour can provide evidence about accountability, escalation and the organisation's capacity to recognise and manage its own weaknesses. The underlying source material makes exactly this distinction: a significant weakness accompanied by transparent management, credible remediation and good evidence can present a different decision from a similar weakness that management cannot explain or appears unwilling to acknowledge.
This is one reason experienced ODD judgement does not translate well into a fixed list of prohibited findings.
“A useful discipline is therefore to separate residual risk from evidential confidence.”
Separate the risk from confidence in the conclusion
Even after residual risk has been assessed, an important question remains: How securely is that conclusion supported?
Two managers may receive broadly similar risk assessments while the evidence behind them is quite different.
At one, policies, operating records (artefacts) and interviews all point towards the same operating reality. At another, the conclusion relies heavily on management representation because there is limited evidence of how the arrangement works in practice.
Those are different decision situations.
A useful discipline is therefore to separate residual risk from evidential confidence: what exposure remains, and how securely is that judgement supported? This distinction is built into Lestrade's evidence framework precisely because different combinations of risk and confidence can have different implications for the investor.
Lower confidence does not automatically mean higher risk, still less that the manager should be rejected. It may justify one more piece of targeted evidence, a specific monitoring condition or explicit acknowledgement that part of the conclusion remains less securely established than the institutional investor would ideally prefer.
That is more informative than converting every remaining uncertainty into another finding.
Keep remediation in the future tense until it works
Managers often respond constructively during an ODD review.
A responsibility is clarified. A control is redesigned. A policy is approved. A remediation programme is agreed. All of that matters, but there is a practical distinction worth protecting: a credible future operating model is not yet the current operating model.
If governance responsibilities were unclear, a revised policy can establish a better formal arrangement. It does not yet demonstrate that people now exercise authority differently. If a control failed, designing a stronger control is an important step, but evidence that it operates belongs to a later stage.
In live diligence this distinction can be surprisingly easy to blur, particularly where management's proposed solution is convincing. The future state starts influencing today's risk assessment before the organisation has actually reached it.
An investor can still proceed before remediation is complete. That may be entirely reasonable. But the outstanding assumption should remain visible and have a route into subsequent monitoring or follow-up.
Otherwise promised improvement quietly becomes demonstrated improvement on paper.
“The professional task is to distinguish between something worth knowing and something that genuinely changes the basis for delegation.”
Make the decision implication explicit
A material ODD finding does not create only two possible outcomes.
It may require remediation before funding. It can lead to additional reporting, an earlier second round review, a specific monitoring trigger or a condition around governance, succession or a service-provider transition. In more significant situations it may affect the proposed exposure, or make the operational risk exposure difficult to justify altogether.
Other findings should change very little.
That is equally important. An ODD function that feels obliged to attach a condition or escalation to every observation can become as unhelpful as one that rarely challenges anything.
The professional task is to distinguish between something worth knowing and something that genuinely changes the basis for delegation.
The final report should make that implication visible. It should be reasonably clear whether an issue is informational, warrants monitoring, requires additional evidence or remediation, changes the overall risk view, or is serious enough that the reviewer can no longer support the delegation on the evidence available.
ODD should not make the investment decision. The investment proposition, portfolio role, expected return and the institutional investor's own risk appetite still matter, and the final response belongs to the investor.
But the ODD function has not fully done its job if the investment committee understands the finding but is still unclear about what the reviewer believes should change.
Some findings confirm that the investment can proceed as planned. Some change the conditions around it. A small number change the decision itself.
Good ODD makes that difference clear enough for the investor to act on... and defend.
Thinking about how ODD findings feed into investment decisions? Talk to Lestrade
