That other four letter word – Risk!
With all these celebrities and national treasures dropping dead so far this year, it was beginning to look like a high risk strategy to be in the news or have any profile in the media in case you suddenly disappeared without a trace! The same is true of regulation. Regulation comes and regulation goes.Change is all around us and some of it is for the better…..or so it seems.
The big news last summer (at least in Ireland) was the release of the Central Bank’s feedback statement on CP86. Wow, CP86 I hear you say. What the heck is CP86? Well, in reality, it is quite a major change for the Irish Fund’s industry as it was intended to clarify the designated person’s role in terms of responsibility for managerial functions. In short, who is responsible for what or, in other words, where does the buck stop?! Put another way, who is in the firing line if it goes wrong?
Previously, the regulator had a list of 12 management functions that were deemed to be necessary and were expected to be allocated to the Board of Directors. These have now been amended to just 6.
- Regulatory Compliance
- Fund Risk Management
- Operational Risk Management
- Investment Management
- Capital and Financial Management
- Distribution
These magic 6 functions are what all Funds must demonstrate they have oversight of. As a provider of these to our Funds, we have to demonstrate that we have all these functions covered by the Directors. For my personal sins I look after Investment Management. Oh the joys! Whilst the Directors may not actually do the work, they have to ensure the work is completed to the correct level and that the reporting is of sufficient quality that meets the Bank’s requirements. The Central Bank offers some guidance on delegate oversight by reminding Boards that “The board should receive and be satisfied with regular reports assessing risk levels relative to the risk appetite(s) for the investment funds under management”.
There are many functions that are subsequently outsourced. In our case we ask RiskSystems to look at the “Fund Risk”. They have the technology to enable a Board and the Fund Managers to see straight through the portfolio every time the NAV is struck which gives everyone comfort that the Fund(s) is doing what it should be doing and not “breaching” the rules by which it is managed. This enables us as Promoters of the Company to sleep at night and gives the Fund Managers and Investors comfort that everything is being closely monitored. However whilst we have this covered, the question is what are other Fund Companies doing? There are a lot of ManCos in Dublin and Luxembourg who rely on monthly responses not daily like Gemini. This means lots of “risk” can build up during the preceding 30 days or so. This, in my view, is not satisfactory. As Simon O’Sullivan, Head of Business at RiskSystems said in their response to the CBI:
“We provide independence between the portfolio management team and the risk management team as required….. A key objective must be to reduce the chances of a Madoff or Weavering type fraud taking place and we believe outsourced independent risk can diminish the chances of such cases occurring. Whilst the very large houses have well-resourced internal risk management functions, the vast majority of smaller investment houses likely do not have anything approaching best in class risk management”
It is therefore vital that businesses in the Fund’s industry take risk seriously and don’t just do a tick-box on the responsibilities. Virtually all promoters of funds are struggling to get to grips with a wide variety of legislation currently including AIFMD, MIFID2, UCITS V, FATCA, ICAV etc. One would imagine the last thing a promoter needs right now is further changes in the legislative framework, no matter how sensible. In addition, many promoters are having to either bear considerable cost of regulatory compliance themselves or are trying to pass the cost to investors. It’s not getting any cheaper to run a fund these days and these costs are inevitably risk associated costs.
In terms of risk management, given the focus on clear segregation between the front office and risk management function, it is no surprise that the designated individual for risk may not also be responsible for the monitoring of investment policy, investment strategies and policy managerial function. This decision was taken on the grounds that it weakens the performance of these managerial functions and involves too many potential conflicts.
In addition the Central Bank has recognised that the management company’s operational risk is distinct from the risk management associated with its underlying investment funds. Therefore the Central Bank is separating risk management into two separate managerial functions – fund risk management and operational risk management. These separate managerial functions may, but do not need to be, conducted by a single person. However my view is very clear; they are separate and the skills needed are very different. Whilst some may have the ability to multi-task I believe it is in the best interest of Investors to have independent risk assessment that can review, comment and advise Boards as to what the Funds and their Managers are doing and what risks are investors are exposed to. So will we see that being imposed? Doubt it, but I remain in hope!
Have a great week
Stuart Alexander
Co Founder & CEO