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Managing Risk for Alternative Investment Managers

Posted on Tuesday 14th January, 2014

The AIFMD has introduced the concept that the risk management function needs to be functionally and hierarchically separate from the portfolio and operation management functions. Good fund managers operating in the alternatives sector have obviously been successfully managing their risk function for many years but the AIFMD now presents managers with some structuring challenges. This is especially true for boutique fund managers that have historically outsourced their operational infrastructure to service providers whilst the staff or the partners at the fund manager have concentrated on managing the money, transacting deals and fund raising. This means many fund managers intending to become AIFMs are still unsure about how to organise their risk management function under AIFMD.

The AIFMD says that where proportionate, AIFMs need to ensure 'functional and hierarchical separation'. In reality this means that:

  • Individuals performing the risk management function are not supervised by those responsible for the performance of the operating units;
  • They are not engaged in the performance of activities within the operating units;
  • They are compensated independently of the performance of the operating units;
  • The remuneration of the senior managers in the risk management function is directly overseen by a remuneration committee.

Where the above would be considered disproportionate, AIFMs may seek disapplication of the above, but would still need to ensure that there are adequate safeguards against 'conflicts of interest', so that the risk management function is independent. In reality this means that:

  • The risk management function is carried out using reliable data;
  • Remuneration of individuals involved in risk management is independent from the performance of business areas;
  • The risk management function has the same authority level as portfolio management and is reviewed independently of it;
  • The risk management function is represented at the governing body or supervisory function level;
  • Any conflicting duties are fully segregated.

In addition, where proportionate, the following Corporate Governance conditions also need to be fulfilled:

  • The AIFM's internal audit function or an external entity must regularly review the performance of the risk management function.
  • If a Risk Committee has been established this must be suitably resourced and not have any undue influence on the performance of the risk management function or be influenced by the portfolio and operational functions.

Every alternatives fund manager is different so each managers needs to review its structure and decide how best to comply with the AIFMD requirements. However, a particular challenge for managers is that senior and experienced partners or directors will not gladly give up their portfolio management roles so funds may need to recruit experienced risk managers or look to the outsource the function to an experienced provider of risk management services. Managers should also be aware that their newly appointed Depositaries will be keen to ensure that managers have adequately addressed these AIFMD requirements so an early discussion with them may be advisable.

Host Capital was established in 2004 and specialises in providing a truly independent risk management service to fund managers. We can work with all the investment managers and funds existing service providers to minimise any disruption. If you would like to discuss any matter related to this article then please do not hesitate to contact us.

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