Blog

A quick view on Solvency 2

Posted 14.03.2011

From really bad to a bit better but still….

Solvency 2 is about the regulatory capital Insurance companies have to put against their investments portfolio that back up their potential liabilities.

Hedge Funds are classified as “Equities” as far as riskiness is concerned. The bad news is they are included in the “Other Equities” bucket, initially calling for 55% capital allocation against 45% for “Global Equities”. Up there with Commodities, Private Equity and Emerging Markets.

This clearly does not recognise the fact hedge funds, using the HFRX Global Hedge Funds Index, shows a regulatory stress of 23% (source AIMA).  So far the only concequence of that has been a lowering of the capital charge to 49%, still higher than “Global Equities” and still failing to recognise Hedge funds’ low stress level.

The alternative for Insurance companies would be to develop and in house model that would them to better qualify the hedge funds they invest in. This requires willingness of the Insurance companies to do so … and willingness from the hedge funds to provide them with the information they will need to achieve that.

By no means an easy feast…

OWL quick note on SEC registration

Posted 10.03.2011

Among other fine articles in FTfm this Monday, you will have noticed Countdown to Registration, which deals with the obligation for most investment managers in this country to obtain SEC registration by mid-July. Understandably, there is a great deal of fury at the high-handed antics of US legislators, seeking to impose US regulation outside that country. But getting wound-up is not going to change the requirements. AIMA, who have been heavily involved in attempts to mitigate the impact of this obligation are reported to be resigned to it. The fact is that if you should be registered and are not, you are not going to be able to do any business in the US, because the SEC will be on your tail. If, on the other hand, you don’t need to be registered, you would be well advised to be able to prove it. To assist firms to deal with this issue, one way or the other, OWL has formed an alliance with a firm of US lawyers in London who will advise on your need or otherwise for SEC registration and assist with that process; should it then be necessary, OWL can  assist you to comply with the relevant SEC regulations.

Whatever your plans, bear firmly in mind the very limited time available. This is not something to be tackled at the last minute.

Just a few points on UCITS

Posted 7.03.2011

I sat in a seminar the other day where UCITS and more specifically Alternative UCITS were discussed and it became quite clear to me that there were a few misconceptions flying around. I just wish to clarify a few points:

- Purpose: the UCITS regulation was introduced to passport funds that are intended to retail distribution. No surprises that it does not naturally fit any type of strategies

- Liquidity: UCITS funds do not have to offer daily liquidity. Weekly or bi-monthly are perfectly acceptable

- Risk reporting: UCITS funds have to make sure they comply with the portfolio and risk rules as defined by the directive. They need to produce and store documents that prove this daily compliance. It is also critical to have some procedure in place to make sure breaches are handled as regulation requires and eventually reported as the case may be.

- Liquidity: is not 100% guaranteed with UCITS; they can suspend redemption and “gate” if circumstances dictate

- Security: some UCITS funds have turned sour…. there is no such thing as a total guarantee.

An Offer from the wise OWL…

Posted 7.03.2011

Advisory & Consulting Service

Service description

The service provides investment firms with a combination of regular and on-demand advice and briefings. Focused on FSA and European regulation, the purpose of the service is to assist firms to keep up to date with their ever-expanding and constantly-changing regulatory obligations and to determine the best means of fulfilling them. The service is usually provided to Compliance, to Board and other senior management and to non-executive directors, all of whom have regulatory responsibility and liability.

The focal point of the service is the quarterly briefing, provided by OWL at the firm’s offices. The informal format provides the opportunity not just for an update on external change and new regulatory requirements, but also for discussion of the likely impact on the firm. Briefings vary in duration but generally last for about an hour. In addition to the briefings, the service includes access to OWL’s extensive regulatory expertise at any time. The subscription does not include the cost of providing training or conducting research.

UCITS Upgraded – Could this be a genuine benefit from the EU?

Posted 17.01.2011

UCITS Upgraded – Could this be a genuine benefit from the EU?

Aware that I am even more Euro-sceptical than most,

it is really quite rare for me to suggest that an EU action might genuinely provide a benefit, either to the industry or to consumers. But so it is this time. However, as no silver lining comes without its cloud, we will get the good news quickly out of the way so that we can then focus on the inevitable drawbacks.

For really quite a long time, like ten years, the European Commission has been trying to introduce a ‘management company passport’ for UCITS. After a number of ham-fisted attempts, they may have finally pulled this off in UCITS IV. The purpose of the management company passport is to make it possible for a UCITS operator (NB we are not talking about the investment manager) to run a UCITS fund that is domiciled in another EEA country. However modest that may sound, it is quite a significant step and tackles head on the protectionism that is particularly noticeable in Dublin and Luxemburg. It is not difficult to see why this passport might be unpopular in countries that have developed financial services on an entirely export basis with no significant domestic sales. The regulators in those nations have little interest in investor protection and much in attracting the regulatory arbitragers and the business that clings to the coat-tails of investment funds, so well evidenced by the branches and subsidiaries established in those jurisdictions.

But for the UK it is a different story.

Read more

The Remuneration Code – the policy is now clear

Posted 22.12.2010

The Remuneration Code – the policy is now clear

Few will be unaware that the Remuneration Code, originating from G20, codified by the European Commission and enacted by the FSA, is about to strike. The European directive – CRD3 – set the date at 1 January 2011 and all of us in Europe must scramble to comply with that unreasonable timeframe. Now that FSA has published its policy statement we know where we stand. Well, more or less.

Setting aside for the moment the big picture questions of whether the Code achieves its aim of risk limitation and the reduction of the probability of a further banking crisis, the industry needs to consider its position, as it is now revealed to us. Remembering that FSA has anything but a free hand, the Regulator’s use of the proportionality provisions to mitigate the impact on the fund management industry is most welcome. The greatest impositions in the directive have been disapplied to those who do not regularly commit their balance sheets to risk. They will not be compelled to apply deferral measures to bonus payments and they will not have to pay those bonuses substantially in shares. The sigh of relief is audible; a significant threat to the competitiveness of the industry is lifted, for the time being at least.

Time is of essence

Read more

Implementing the Remuneration Code

Posted 21.12.2010

To be implemented by Jan 1st

It is no surprise really that CP10/19 has received more attention than the FSA’s other eighteen consultation papers this year put together. Remuneration is a big issue and a political hot potato into which the FSA risks being drawn in and melted. By now everyone will be familiar with the main features – deferral and payment in shares – but most will not yet have given serious thought to the practicalities of implementation.

This is a consultation that shows further signs of the Regulator’s growing europeanisation. Not only is the process absurdly rushed, thanks to the European timetable for CRD III, but its wording is obscure and its implementation vague. Appealing as it may be to experience such flexibility in regulation, it is bad regulation and results in uncertainty, subjective assessment and resentment. As europeanisation progresses, we can look forward to much more of the same.

Generally firms expect to be able to be able to hold their fire until they can see the whites of the eyes of the new regulations. Not so this time. The European officials have again demonstrated their disdain for facilitating national consultation, leaving the FSA the task of dragooning the industry to meet the deadline of 1st January. The flexibility that they proposed is little short of fudge, for which we should grateful even if we don’t like the taste. The use of proportionality as a smoke screen for staggered implementation with key elements held over to after the legal time-limit.

Nevertheless, at least partial implementation is required by 1 Jan. Few firms will find it realistic to wait for the confirmed rules in November before starting the necessary programme of implementation of the “appropriate governance arrangements”.  Some will be lucky or prescient enough to find that they already meet the obligations; most will not. Immediate attention is needed to remuneration policies, to record-keeping, to the remuneration committee, to the involvement of Risk and Compliance, to employment contracts. All of this is the home work prior to the main test of full compliance by 1st July 2011. Read more

Implementing the Stewardship Code

Posted 21.12.2010

Heard of the Stewardship Code?

The prize for the least well sign-posted rule change must surely go to the FSA’s work on the Stewardship Code. Indeed so obscure was the FSA’s publication of the new rule, that the probability must be that only a small minority of the firms affected will have complied by the now-passed deadline of 6th December. Rule changes sneaked out through anonymous consultations and without any policy statement beg many questions, the most interesting of which is why is the FSA indifferent to mass non-compliance with this requirement?

But first the facts. The new rule (COBS 2.2.3R) requires all managers of institutional money to publish a statement setting out how and to what extent they comply with the Financial Reporting Council’s Stewardship Code. As the FSA announced just three weeks ago, this should have been done by 6th December. If you did not know that, join the club. Read more

What should we expect from VaR?

Posted 11.11.2010

In this post we will discuss what VaR is, why it is used and what it can – and cannot – tell us; from a user point of view.

VaR has three main goals:
  • It puts a figure on the risk taken by a business, in normal circumstances.
  • It allows consolidating many different businesses and their related market risks into one nice number.
  • It enforces a disciplined and organised way of looking at the books, with the option being available to cap the risk appetite with risk limits – VaR or notional based.
“Normal” risk

Normal as in “in normal market conditions”; this means “as the market has behaved in a more or less distant past, over a certain period”.  It is always based on the past behaviour of the portfolio/book constituents. Therefore, by nature, VaR will NEVER capture extreme market situations, unexpected events or “fat tail” risks

Just one number

It produces one number that encapsulates a certain vision of the loss that a portfolio made of many different assets could experience, under normal market conditions. It is not a magic number that tells a manager all about his risks.

Widely promoted (if not imposed) by regulators

This has successfully allowed them to:

  • Provide a number to evaluate of risk on which they could base capital requirements calculations;
  • Put pressure on Financial Institutions to get organised and pay “some attention” to their risks. How many banks did not have a risk department when VaR was imposed?
Not a standalone number

It was not and is not supposed to be the only number to use. However, as a trend, it can be interesting. A growing VaR number is also a clear sign that “something is happening” and that some investigation is worth doing. It should focus minds and trigger discussions. Another benefit is that producing VaR numbers requires a high quality infrastructure, which can deliver other risk/p&l analysis and enforces operational discipline.

VaR gives a view on the relative contribution of various assets or portfolios. It is a tool. It cannot produce a full picture of what the future could be. It is an attempt to anticipate what could happen in the future with an evaluation based on “rules”. That means you must be aware of the assumptions in order to understand its limitations.

All VaR does is give us an estimate of the maximum loss a portfolio should experience, under a certain probability; assuming the markets behave as they usually do.

Academics and practitioners have established a variety of numbers and concepts to capture other aspects of risk. Stress tests, scenario analysis and historical analysis all provide useful information, with some trying to address more specifically the infamous “the fat tail” risks. However, they only tell part of the story: using VaR coupled with these measures will contribute to producing a clearer, more all encompassing picture of risk. But nothing offers a full insurance against any possible future events.

VaR is part of the toolbox to understand risk

The first job of a CEO of a financial institution is to make sure the company under his watch survives to fight another day; and not to bet the shop in order to increase profits. It is impossible to foresee how risk will materialise. The only thing that experienced people know is that it will. Risk measures will help keep it under control, with resulting consequences at reasonable levels; good judgement – and sensible sizing- will make sure the unexpected is not fatal. This is ultimately the talent of management, the role and responsibility of the captain of the ship. Risk management is just a helper; and VaR part of the toolbox.

αpolloTM liquidity

Posted 2.11.2010

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  2. Low correlation to major markets
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  5. Low volatility, low correlation
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