AIFMD Surgery Webinar Risk Management

April 8, 2023CORDIUM POWERPOINT MASTER 1

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

April 8, 2023

Questions

3

You can submit your questions using the Questions area in the GoToWebinar console

© Copyright April 8, 2023

Result from VoP & Business Plan webinar poll

4

44%

56%

Have you documented risk management ar-rangements to AIFMD standards?

YesNo

70/130 attendees answered

April 8, 2023© Copyright

5

Elisa Perna, Head of Risk Consulting, [email protected]

Chair: Bobby Johal, Managing Consultant, Technical, Cordium

Panelist: Joe Vittoria, Chief Executive Officer, Mirabella

April 8, 2023© Copyright

AIFMD Surgery Webinars: Risk Management

mailto:[email protected]

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.

April 8, 2023 6© Copyright

Topic 1 – Risk Policy: design considerations


AIFMD Key Requirements on Risk Management

April 8, 2023 8

The AIFMD requires AIFMs to draft a risk management policy that links the firm’s investment strategy with its systems and procedures.

© Copyright

Focus: Leverage Calculation, Limits and Supervision

April 8, 2023 9

Smaller AIF

Leverage Limits and Supervision

Disclosure to investors

Disclosure to competent authorities

Calculation Methods

Leverage on ‘substantial’ basis

© Copyright

April 8, 2023 10

1) Robust Risk Process and GovernanceOverall 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) calculationGross and Commitment Method

3) Adequate Risk Management DocumentationA 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.

Summary of Key Targets

© Copyright

Things to do list

April 8, 2023 11

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

Topic 2 – The Risk Governance Puzzle


Why a puzzle?

o AIFMD requires AIFMs to design a risk management function which translates four main principles into practical arrangements.

April 8, 2023 13

Independence

Non-conflicting remuneration

Authority

Competence

© Copyright

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.


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.


Non-conflicting remuneration

o Remuneration of Risk Managers: Remuneration should reflect the achievements of the objectives linked to the risk management function:

o Competency assessmento Role objectiveso Personal objectives


Outsourcing as a solution

o AIFMD allows AIFMs to outsource risk management to a third party firm. This can help solve the puzzle:o Competento Independento Contractual authority equivalent to portfolio managerso 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.


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 firmso 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.


Topic 3 – Hedge Funds and Private Equity - different approaches to risk


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.


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.


2. Liquidity Risk

a) Market liquidityo 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 liquidityo Monitoring funding risk is central to effective risk management in both hedge

funds and private equity fundso 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.


3. Leverage Risk

a) Borrowingo Hedge Funds - Borrowing leverage is the exposure created whilst increasing

the equity capital invested in the fund by borrowing money.o Private Equity - Borrowing leverage is typically associated with LBO

transactions. Secondly, debt can be also used by the investee companies to operate their businesses .

b) Other Leverage conceptso Hedge Funds - Leverage is often embedded in derivative positions, especially

in instruments like futures which are traded on margin.o 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.


Questions

24

You can submit your questions using the Questions area in the GoToWebinar console

© Copyright

For more information or sales enquiries please contact [email protected]

April 8, 2023

mailto:[email protected]

AIFMD Surgery Webinars

Next…

25© Copyright

Depositaries – December 2013Registration details coming soon!

Annex IVRemuneration

Coming soon…

April 8, 2023

AIFMD Surgery Webinar Risk Management

Education