Market fluctuations tied to rapid changes in US trade and tariff policies are creating a wave of trading activity – and with it, a surge in operational risk for asset managers.
Tim Sullivan, asset management industry leader at WTW, sees a direct connection between this volatility and the likelihood of trade errors, raising questions about how insurance coverage can and should respond.
“The increased trading activity witnessed during these times can often be followed by trade errors,” Sullivan said. “In 2020, for example, the fear created by the pandemic caused significant volatility in the markets and generated a costly uptick in trading errors.”
Trade errors, Sullivan said, can take many forms. “Common categories include, but are not limited to, data entry errors, missed deadlines, failure to execute, miscommunicated trade instructions, collateral management failures and breaches of mandate.”
Despite this variety, firms often assume their insurance policies will automatically respond to these events. But according to Sullivan, reality is more nuanced.
“When asked whether a loss is covered under a policy, a common refrain within the insurance industry is, ‘It depends,’” he said. “That’s because it does indeed depend upon the circumstances of the loss itself, the extent to which the asset manager is legally liable, and the terms and conditions of the specific policy being reviewed.”
Sullivan outlined three insurance policies that asset managers commonly look to in the event of a trade error: Cost of Corrections, errors and omissions (E&O) liability, and fund D&O/E&O liability.
“Cost of corrections is intended to reimburse the manager for those amounts it proactively pays to make a harmed investor whole, so long as the loss results from the manager’s error or omission,” he said. “Cost of corrections doesn’t require a third-party demand for coverage to apply.”
By contrast, the E&O policy requires a formal claim from a third party. “A third-party claim is required to trigger coverage under an E&O policy, and such claim must allege an error or omission in the performance of, or failure to perform, investment management services,” he said. “E&O claims are generally brought by investors or regulators, and coverage usually applies to defense and legal expenses as well as any resulting judgments or settlements.”
Sullivan added that in cases where a fund itself is the target of a claim following a trading error, fund D&O/E&O coverage may be triggered.
“If a trade error causes a loss to a fund and a third-party claim is made against the fund and its directors/trustees alleging a breach of duty or other covered act, this may trigger coverage under the fund’s D&O/E&O liability policy,” he said.
While insurance response may vary, Sullivan stressed that asset managers can take steps to improve the likelihood of recovery.
“Conducting a proactive and thorough review of one’s insurance policies is important and will help mitigate surprises in the event of a loss,” he said.
Among the most important provisions to understand, according to Sullivan, are claim reporting requirements. “One of the most common challenges that arises in the event of a claim is late reporting to the insurance company,” he said. “All policies require claims, as defined, to be reported within a certain period of time once a predetermined set of individuals become aware of the claim.
“Taking steps to further improve internal communication, such as incorporating insurance reporting procedures into the firm’s trade error manual, will mitigate the risk of coverage challenges due to late reporting.”
Another key area is how insurers define trade errors. “The term ‘trade error’ can be used liberally and may not align with the actual language found in the policy,” he said.
Some policies include a broad range of errors, while others limit the definition. “Knowing the parameters of this coverage ahead of time will avoid future surprises.”
Additionally, most policies require insurer approval before law firms are retained or defense costs are incurred. “Reviewing and understanding these requirements in advance will reduce friction if a loss or claim occurs,” he said.
Sullivan also pointed to possible regulatory developments on the horizon. “The Securities and Exchange Commission may soon examine the resiliency of asset managers’ risk frameworks, their compliance with the marketing rule and how they performed during the tariff-driven volatility,” he said. “As this may signal heightened regulatory risk, asset managers should consider the coverage available for such claims under the D&O/E&O policy.”
In some cases, insurance may even help firms prepare. “Some D&O/E&O insurers will cover a percentage of costs associated with a mock regulatory audit of the insured organization,” Sullivan said. “Such audits may strengthen the risk profile of an insured.”
While coverage terms vary by geography, market, and organization, Sullivan recommended close coordination with brokers.
“Organizations should discuss with their broker the breadth of the coverage provided by their insurance policies in relation to these coverage considerations,” he said.
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