By Sarva Srinivasan, Global Head of Strategy & MD, NeoXam, Americas

The Federal Reserve’s decision earlier this month to raise interest rates by a quarter point has consequences considerably bigger than simply the cost of borrowing going up.  Away from the trading screens, Warsh’s decision to jack up the target range for the fed funds rate from 3.75 to 4.00 per cent provides a tricky test of the financial plumbing underpinning the investment management industry.

When interest rates move, there is a ripple effect through portfolios as bond prices adjust, effective yields alter, and accruals need recalculating. On top of this, performance figures also need updating and for less liquid assets – determining the effect of a new interest rate environment can be considerably more complicated from an operational perspective.

The challenge is particularly acute because much of the asset management industry still operates with a fragmented technology estate that has data sitting across different systems and spreadsheets. For Instance, investment accounting may be separated from portfolio management, which means, different teams may work from slightly different versions of the same information.

That may be manageable when the rate environment is more predictable like it was between 2011 and 2020. However, it becomes much less comfortable when monetary policy changes direction as we saw last week. When rates change, even just ever so slightly, the real challenge is being able to explain how you arrived at a specific valuation for an asset.

Investors, auditors, regulators and internal risk teams increasingly expect fund managers to provide detailed answers to questions in order to demonstrate the lineage behind valuations and performance. For instance, what market data was used? Which assumptions changed? When was a position revalued? Why is today’s figure different from yesterday’s?

If answering those questions requires someone to reconcile several systems manually, the weakness is in the infrastructure as opposed to the rate environment. That matters because Wednesday’s Fed decision is another reminder that asset managers cannot build their operating models around an assumption of stable interest rates. The long period of exceptionally low and relatively predictable rates is firmly behind us.

Technology consequently needs to be designed around change rather than stability. Automation helps up to a point, but automating a poor process only allows inconsistent information to travel faster. What matters more is ensuring the same reliable data can flow through positions, valuations, accounting and reporting, with a clear record of where it originated and how it changed.

This becomes increasingly important as portfolios span multiple jurisdictions and different accounting regimes. The operational challenge is no longer simply processing a portfolio of listed securities at the end of each trading day. The financial industry often discusses operational resilience in the context of dramatic events such as market crashes. But resilience is also tested by ordinary monetary policy decisions.

The Fed moving rates by 25 basis points would have led to yield curves being adjusted and portfolios being repriced, all while thousands of positions were being recalculated and explained. For financial institutions with modern data and investment accounting infrastructure, that should be routine. However, for those still dependent on fragmented systems and manual reconciliation, a small change in interest rates can expose much bigger weaknesses. Sometimes even just a small rise in basis points tells us as much about financial infrastructure as it does about monetary policy.