Back to the future?
Key Message
For the first time in the history of asset management risk management is on a par with portfolio management as a result of legislation known as the Alternative Investment Fund Managers Directive (AIFMD). AIFMD states that the AIFMD must ensure that “the risk management function is represented in the governing body or the supervisory function, where it has been established, at least with the same authority as the portfolio management function;”1 Almost all non-UCITS collective vehicles are caught – including hedge funds, private equity funds and real estate investment trusts.
AIFMD codifies what was effectively best practice in risk management. Investment managers no longer have a choice as to whether to have a risk management function or not – risk management is hereafter enshrined in legislation. As a result of AIFMD they must have an independent risk management function (An AIFM must “functionally and hierarchically separate risk management from operating unit, including portfolio management “2).
Furthermore AIFMD insist that “those performing the risk functions are not supervised by those responsible for the performance of the operating units, including the portfolio management function, of the AIFM”3 . AIFMD is very prescriptive and broad “all risks must be monitored at all times”. As a result the development of a comprehensive risk function that can meet the regulatory requirements causes a considerable burden to those institutions with little or no background and/or personnel with the required expertise.

Where next?

The transition period has given mangers, regulators and investors time to prepare; however it is very apparent a large degree of unpreparedness and some confusion remains. So far regulators have been busy assessing applications prior to the deadline of 22nd July. As this deadline passes application assessment will turn into enforcement; managers may have ticked all the boxes but the regulators will be coming and looking for proof that what the manager said is being done is actually being done. It is quite simple to tick a box to say you have an independent risk function that is monitoring all risks at all times – it is quite a different proposition to demonstrate this to the regulators satisfaction.
We have no doubt large fines are coming as the regulators get to grips with the legislation and show their mettle similar to how they have shaken up the European banking industry over the past few years e.g. with the banking stress tests and single supervisory mechanism (SSM) for the euro zone.
In many cases European regulators have increased their staff significantly since the crisis in 2008 – fines (or Administrative Sanctions Procedures as they like to call them) are seen by some people as a way of the cost of regulation paying for itself. IOSCO4 is also looking to harmonise fines and punishment and reduce the amount of regulatory arbitrage as managers seek to exploit jurisdictions with weaker regulation and fines.
1 Article 42, (Safeguards against conflicts of interest), paragraph 1d
2 Article 15, AIFMD directive 2011/61 EU).
3 Article42, 1a Level 2
4 International Organisation of Securities Commissions

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