Published on March 4, 2014
CORDIUM POWERPOINT MASTER March 4, 2014 1
AIFMD Surgery Webinars - Risk Management The webinar will begin shortly… You can join either by VoIP or dial in by telephone Follow call in details if you select to use Telephone audio March 4, 2014 2
Questions You can submit your questions using the Questions area in the GoToWebinar console © Copyright March 4, 2014 3
Result from VoP & Business Plan webinar poll Have you documented risk management arrangements to AIFMD standards? 44% Yes No 56% 70/130 attendees answered © Copyright March 4, 2014 4
AIFMD Surgery Webinars: Risk Management Elisa Perna, Head of Risk Consulting, Cordium email@example.com Chair: Bobby Johal, Managing Consultant, Technical, Cordium Panelist: Joe Vittoria, Chief Executive Officer, Mirabella © Copyright March 4, 2014 5
Topics o Developing a risk management policy: design considerations. o The Risk Governance puzzle: problems and solutions. o Hedge Funds and Private Equity firms: same regulation, and different approach to risk. © Copyright March 4, 2014 6
Topic 1 – Risk Policy: design considerations © Copyright March 4, 2014 7
AIFMD Key Requirements on Risk Management The AIFMD requires AIFMs to draft a risk management policy that links the firm’s investment strategy with its systems and procedures. © Copyright March 4, 2014 8
Focus: Leverage Calculation, Limits and Supervision Smaller AIF Leverage Limits and Supervision Disclosure to investors Disclosure to competent authorities Calculation Methods Leverage on ‘substantial’ basis © Copyright March 4, 2014 9
Summary of Key Targets 1) Robust Risk Process and Governance Overall the AIFMD does not directly restrict levels of risk to be taken by AIF however it requires the set up of robust and formalized risk management on previously less regulated AIFs. 2) Correct Exposure (leverage) calculation Gross and Commitment Method 3) Adequate Risk Management Documentation A documented Risk Policy should cover all risks faced by the AIF (market, counterparty, credit, liquidity and operational risks), include risk limits, breach policy, back and stress testing and all relevant sub policies. © Copyright March 4, 2014 10
Things to do list Review you risk management arrangements and if necessary take expert advice Decide if you want to outsource risk management. This might save you money If delegation is not an option you should start implementing the AIFMD required standards and choose an AIFMD compliant risk system If you don't have an internal audit function you might appoint an external firm to provide regular and independent risk management reviews © Copyright March 4, 2014 11
Topic 2 – The Risk Governance Puzzle © Copyright March 4, 2014 12
Why a puzzle? o AIFMD requires AIFMs to design a risk management function which translates four main principles into practical arrangements. Independence Competence Non-conflicting remuneration Authority © Copyright March 4, 2014 13
Competence: Risk Management is not Compliance o The Risk Management function is a complex task that requires specific skills. o Risk Management has a critical role in shaping the investment strategy and supporting the decision making process. o Compliance does have an oversight role in risk management. © Copyright March 4, 2014 14
Independence and Authority: The role of the Risk Manager o A risk manager: - cannot be subordinated to the investment functions; and; - should have at least the same level of authority as the portfolio management function. o Ideally, the CEO (if not conflicted by investment responsibilities) or a Chief Risk Officer reporting to either the CEO or the Board should cover this role. © Copyright March 4, 2014 15
Non-conflicting remuneration o Remuneration of Risk Managers: Remuneration should reflect the achievements of the objectives linked to the risk management function: o Competency assessment o Role objectives o Personal objectives © Copyright March 4, 2014 16
Outsourcing as a solution o AIFMD allows AIFMs to outsource risk management to a third party firm. This can help solve the puzzle: o o o o Competent Independent Contractual authority equivalent to portfolio managers Non-conflicted remuneration o AIFMs are also required, subject to proportionality, to regularly review the performance of the risk management function – internal audit or external professional. © Copyright March 4, 2014 17
Proportionality o The FCA has clarified the use of proportionality in applying Article 15 (1) Hierarchical and Functional independence of the Risk Management Function: o achieving functional and hierarchical separation may be disproportionate for some firms o an AIFM must be able to demonstrate that specific safeguards against conflicts of interest exist (Art 43) o AIFMs unable to comply with Art 15(1) should include a note to the application form. The FCA will review and assess the safeguards implemented by the firm to ensure that conflicts of interest do not compromise that independence. © Copyright March 4, 2014 18
Topic 3 – Hedge Funds and Private Equity different approaches to risk © Copyright March 4, 2014 19
Why are the approaches so different? o In the more liquid spectrum of alternative investment strategies, risk management is dictated by best practice, hugely supported by market data and quantitative models. o In the PE space, for years practitioners have been struggling with how to integrate private equity and real assets into a more traditional risk management framework. © Copyright March 4, 2014 20
1. Market and Capital Risk o In a traditional risk management framework, risk is typically measured through VAR and Shortfall measures. o VAR methods are based on daily changes of market prices. o As private equity assets are not traded on public markets there is a lack of market price data. o This has led to the development of modified approaches like the Cash-Flow-at– Risk (CFaR) or Investment-Capital-at-Risk (ICaR). Benefits of Diversification o Recent studies have proven that diversification is a key component of prudence in all portfolios. Also applies to PE investments. o Diversification reduces the long-term risk of a private equity portfolio and for large portfolios it is expected to increase the average returns. o However, experience obtained over several market cycles shows that both returns and cash flows tend to become highly correlated during market downturns. © Copyright March 4, 2014 21
2. Liquidity Risk a) Market liquidity o The risk that there is not enough demand for purchasing an asset on the market or on the ‘secondary’ market for PE transactions. o Applies to both HFs and PE funds. The major difference is that PE funds are naturally and structurally illiquid whilst HFs’ illiquidity is related to the fund's strategy, can be only temporary and/or depend on worsening market conditions. b) Funding liquidity o Monitoring funding risk is central to effective risk management in both hedge funds and private equity funds o Hedge Funds - The risk arises when the manager is required to inopportunely liquidate assets and at significant losses or when there is inconsistency between redemption terms and the asset’s liquidity. o Private Equity - Capital calls are made at short notice, requiring investors to have sufficient liquidity available to avoid defaulting on their commitments or entering into distressed secondary transactions. © Copyright March 4, 2014 22
3. Leverage Risk a) Borrowing o o b) Hedge Funds - Borrowing leverage is the exposure created whilst increasing the equity capital invested in the fund by borrowing money. Private Equity - Borrowing leverage is typically associated with LBO transactions. Secondly, debt can be also used by the investee companies to operate their businesses . Other Leverage concepts o o Hedge Funds - Leverage is often embedded in derivative positions, especially in instruments like futures which are traded on margin. Private Equity – Overcommitment occurs when a PE investor commits more capital than they actually have at their disposal. Overcommitment strategies, when leading to a default situation, may result in credit lines being used by the fund at expensive rates. © Copyright March 4, 2014 23
Questions You can submit your questions using the Questions area in the GoToWebinar console For more information or sales enquiries please contact firstname.lastname@example.org © Copyright March 4, 2014 24
AIFMD Surgery Webinars Next… Depositaries – December 2013 Registration details coming soon! Coming soon… Annex IV Remuneration © Copyright March 4, 2014 25
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