1. CORDIUM POWERPOINT MASTER
March 4, 2014
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2. 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
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3. Questions
You can submit your questions
using the Questions area in the
GoToWebinar console
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4. Result from VoP & Business Plan webinar poll
Have you documented risk management
arrangements to AIFMD standards?
44%
Yes
No
56%
70/130 attendees answered
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5. AIFMD Surgery Webinars: Risk Management
Elisa Perna, Head of Risk Consulting,
Cordium
elisa.perna@cordium.com
Chair:
Bobby Johal, Managing Consultant, Technical, Cordium
Panelist: Joe Vittoria, Chief Executive Officer, Mirabella
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6. 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.
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7. Topic 1 – Risk Policy: design considerations
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8. 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.
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9. 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
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10. 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.
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11. 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
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12. Topic 2 – The Risk Governance Puzzle
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13. 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
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14. 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.
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15. 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.
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16. 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
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17. 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.
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18. 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.
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19. Topic 3 – Hedge Funds and Private Equity different approaches to risk
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20. 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.
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21. 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.
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22. 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.
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23. 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.
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24. Questions
You can submit your questions
using the Questions area in the
GoToWebinar console
For more information or sales enquiries please
contact sarah.donnelly@cordium.com
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25. AIFMD Surgery Webinars
Next…
Depositaries – December 2013
Registration details coming soon!
Coming soon…
Annex IV
Remuneration
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