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Combating Spreadsheet Risk in Private Equity Firms

By Geraldine Gibson, CEO, AQMetrics

Since the introduction of the Alternative Investment Fund Managers Directive (AIFMD), Private Equity firms have been coming under increased regulatory pressure to demonstrate stronger systems and controls, particularly around data management.

Many PE firms however still rely heavily on Excel spreadsheets for a range of critical tasks, including portfolio valuations, risk calculations, capital accounts allocations, performance analysis and financial reporting.

This is a problem.

It is estimated that over 90% of spreadsheets in use today contain errors. Which means that PE firms dependant on such spreadsheets face significant – and unacceptable – levels of operational risk.

Operational Risks

The risks are many and varied.

First of all, spreadsheets are powerful tools that put programming capabilities into the hands of non-IT users, which means that critical “systems” can be developed without the normal safeguards, oversight and testing that would be associated with a typical development environment.

As a result, errors – particularly in complex formulae – can slip through and lead to incorrect valuations, which can remain unnoticed for long periods of time.

Secondly, spreadsheets are often not subject to change management controls, which means that users can – either inadvertently or maliciously – make incorrect updates, which again may go unnoticed until it is too late.

Another common problem is the fact that the original author of the spreadsheet may no longer be with the firm. As a result, people could be relying on figures without any understanding of how those figures are being calculated.

Add to this all the other poor practices that have evolved around spreadsheet usage, such as multiple versions existing within a single organisation; poor security and lack of password protection; cutting and pasting cells; etc. and it is clear why over-reliance on spreadsheets can lead to unforeseen operational risks.

Expert Systems

To combat such risks, PE firms are increasingly adopting expert systems, designed specifically to perform their most critical tasks in a controlled and consistent way.

In addition to enabling PE firms to perform core processing functions such as fund accounting and reporting, these expert systems ensure that consistent data definitions and standards are in place, enabling better management information around key metrics, for example.

Such systems can also include: pre-populated data fields to prevent data errors; management and control of complex algorithms used to measure portfolio and credit risk (for example); knowledge upkeep and transfer when people leave an organisation, thus eliminating “key man risk”; and much greater levels of security, with full revision management and audit trails both around who has accessed the system and who has changed data.

Additionally, these expert systems can provide documentation management, for example enabling the storage and indexing of documents relating to specific tasks ans risks.

Making the Change

So, what is stopping PE firms moving from Excel spreadsheets to expert systems?

In some cases, it is nothing more than inertia and an “if it ain’t broke, don’t fix it” mentality. Unfortunately for such firms however, overconfidence in the spreadsheets they have relied on for years can prove extremely costly, once errors do eventually surface.

Other firms may realise they need to do something but may not be aware that better solutions are available, or they may believe that such solutions are expensive and only available to larger organisations. But with the latest cloud-based solutions, barriers to entry are actually much lower than they may think.

In conclusion, with PE firms increasingly coming under the regulator’s microscope, and with data management as a key area of concern, firms who are able to demonstrate that they have the right systems and controls in place will not only be in a much stronger position for regulatory compliance, but will also minimise their operational risk and provide greater transparency to their clients, resulting in competitive advantage.