Nicholas Pratt talks to Alain Dubois, chairman at LyxorAsset Mangement, about the firm’s approach to risk management and the impact of the Alternative Investment Fund Managers Directive on its risk processes.
Lyxor Asset Management, a wholly-owned subsidiary of French bank Société Générale, was founded in 1998 and manages €96.2 billion. In addition to its exchange-traded funds product range (which accounts for €46.6 billion of assets under management), Lyxor has a managed account platform for hedge funds investing which includes more than 120 alternative funds and more than €19 billion.
According to Alain Dubois, the chairman, the risk management requirements of the Alternative Investment Fund Managers Directive (AIFMD) are not the most contentious part and, for many firms, there is nothing required that they do not do already. “The risk-related proscriptions in the AIFMD concerning risk control, or transparency for investors are very reasonable and not out-of-touch with current market practices.
“There has been concern over the possibility that hedge funds might have to calculate and publish the level of leverage they have and the possibility that the regulators might look to control the amount of leverage that firms employ. But there is nothing in the directive that constrains regulators to do this. Certainly, the concern is not the same as that over custody and depositary arrangements.”
RISK CONTROLS
As far as Lyxor is concerned, no adaptation is needed in terms of risk management from the AIFMD – whether it is in liquidity control, stress tests or position management, says Dubois. “We are already doing much more than required.”
Lyxor has a managed account hedge fund platform where the management is delegated to hedge fund managers but the risk controls are kept in-house.
Moreover, some requirements of AIFMD are already in Ucits IV, which applies to Lyxor.
Lyxor has 30 professionals working across six teams: internal control; market risk; credit and counterparty risk; operational and due diligence (specific to the hedge fund industry); and two other teams in charge of ad hoc follow up and transversal projects based in Paris and New York respectively.
“We have a very strong risk department managed by a former trader who reports directly to the board and is independent from the portfolio managers,” says Dubois.
“We have daily or weekly valuations and we analyse all the positions of our traders. Our business model completely separates risk management from portfolio management. But I would say these are basic principles of any risk management function.”
Lyxor also has risk controls when starting a fund or altering the strategy of an existing fund, says Dubois. “The risk management department is involved in this process and has the right to veto these changes. It also sets trading limits for each fund.”
Systematic controls on the funds are performed daily or weekly and, from time to time, on a specific basis, intermediary analysis or controls may be enacted – typically as a result of market events, unusual activity or significant net asset value moves.
MYTH
There is perhaps a myth that a number of alternative investment fund managers have been operating in an unregulated market across Europe and have, therefore, not been subject to any risk management standards, says Dubois. But in Europe, all investment firms are regulated to some extent, even those that are managing non-Ucits funds still have risk requirements that must be met.
Another requirement stated in the directive is the ability for an alternative manager to view specific risk categories (market, credit, counterparty, liquidity and so on) on an aggregated basis across the enterprise and not merely on a fund specific basis. For a firm such as Lyxor, which has a managed account platform, an aggregated stand point for market risk exposures is not especially relevant, according to its risk managers.
Market exposures move a lot and managers do adapt quickly to events, but none has the same time horizon. Therefore, what would qualify as being relevant information (global market exposure of the platform to markets, for example) would ultimately be a metric of limited use. Market exposure and its evolution is more relevant when studied at the fund level.
The picture changes, however, for counterparty risk as the metrics are more stable. The evaluation of a counterparty’s risk on a more granular level, the fund level, for example, is obviously key for investors.
“We also monitor the counterparty risk on an aggregated manner or by business line, such as managed account or ETF,” says Dubois. “This allows us to increase the strength of our set-up in case of market turmoil and use these metrics to build an efficient diversification of counterparties, globally and per fund.
“This means that we can ensure that our operational business continuity plans are top of the class, prioritise the next challenges such as pledges and bilateral collateral management, and be in a good position to drive permanent negotiations to increase the protection of our unit investors.”
Although the AIFMD requirements regarding risk management do not demand anything beyond what most managers are already doing, this and other regulations will lead to an IT challenge, concedes Lyxor.
“We will have to provide more and more information about the funds to our investors and management at an increasing frequency,” says Dubois.
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