21 October 2015

Hedgeweek: AIFMD and the mutation of risk management

Risk managers are making a more conscious effort to not only understand the virtues, but also the limitations, to risk models as they adjust to life under greater regulatory scrutiny, in particular the AIFM Directive in Europe.

The upshot to AIFMD is that managers are increasingly relying on more systems, processes and procedures, and indeed staff, to remain compliant. The role of risk management must now embrace all dimensions of the fund's value chain: portfolio risk management, operational risk management, liquidity risk as well as the management of risks that have been delegated to third party providers; this is the risk oversight function, which has become an integral part of a manager's aggregate risk framework. 

Alan Picone is a managing director at Duff & Phelps' Kinetic Partners division and is versed in understanding the changing dynamics of risk management that hedge funds now face under the Directive. As Picone points out, this requires understanding the processes and risks of the brokers, custodians, administrators and any other companies that support a hedge fund's operations. 

"When you look at risk management from this perspective, and you add to that such things as liquidity management rules, concentration risk rules under the Directive, you can see that the risk management function has become very far reaching as opposed to what it was in the past," says Picone, who adds: "Another key observation is that risk management in the past was viewed as an ex post control, meaning that decisions were taken and then risk management was applied afterwards to measure the potential impact of those trading decisions.”

"The AIFMD changes this fundamentally, such that ex ante risk management becomes critical. We see more interaction of the risk management function with the portfolio management function; these have always been embedded to some extent in hedge funds but not to the degree that risk management becomes, so to say, intrusive. It requires a number of critical tasks such as risk attribution, margin-at-risk impact and so on."

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