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3 SESSION I: How to implement a risk framework for a PE Fund? Yvonne Stillhart, Chairman Akina (Luxembourg) S.A. Kai Braun, Partner, EY, Luxembourg

4 Risk management under the AIFMD ALFI/ALRIM conference 26 th May 2016

5 Key points of the AIFMD Permanent RM function Organizational and governance structure of the AIFM shall embed risk management RM Policies Functional and hierarchical separation from the operating units Implement RM techniques and processes in order to measure, monitor and manage all relevant risks Transparency and reporting requirements Establish, implement and maintain an adequate and documented risk management policy Review of policies Provision to report to senior management and the board Safeguards against Conflict of interests RM processes Review at least once a year the risk management systems Implement stress tests Assess and monitor all relevant risks, in particular liquidity risk Set-up risk limits Align risk limits with risk profile of the AIF Escalation line and remedial actions Page 5

6 Risk management within the AIFM Risk Management among the three lines of defence Monitor effectiveness of control environment and internal control mechanisms (including processes and procedures) Report and address any deficiencies 3rd line Internal Audit Monitor compliance with rules and regulations and ensure consistency with risk profile and limits Provide regular reports on Consistency between and compliance with risk limits Current level of risk incurred 2nd line Risk Management & Compliance Provide risk education and awareness in the organization Regular and ad-hoc reporting (formal or informal) on risks to risk management function 1st line Business Functions Page 6

7 Risk management within the AIFM Market insight: Set up of the Risk Management function Organizational structure RM teams are distinct parts of the AIFM Highly specialized people that are however not specialized with regard to asset classes Groups of 1 to 4 people Key challenges High demand of risk management specialist in Luxembourg Lack of guidance from European regulator, best practices are currently being defined by the industry Priority of focus of the RM industry 10% 70% 20% Recruitment of qualified personnel Completeness and relevance of industry guidelines and best practices Access to peer networks and risk management communities Identification of leading market practice Remaining challenges of the PE/RE industry Page 7

8 Risk management within the AIFM RM function: Responsibilities & Func. / Hier. Separation Risk manager taking on other functions The AIFM must functionally and hierarchically separate the functions of risk management from the operating units, including from the functions of portfolio management Functions the Risk Manager can/cannot take on: Conducting person Compliance officer Valuation officer Accounting officer Director (Derogation may be obtained by CSSF) Portfolio manager Internal audit Duties and responsibilities of the RM Function Implement effective RM policies and procedures; Implement appropriate techniques and arrangements to perform the RM Function; Notify/Update the governing body/senior management; Identify, measure, manage and monitor all relevant risks on an ongoing basis; Ensure that the risk profile disclosed to investors is in line with the risk limits; Implement remedial actions and escalate/report to the board in case of breaches of risk limits or an inconsistency between risk limits and the risk profile. Page 8

9 Risk management within the AIFM Market insight: Interaction with other functions Overlap of roles and responsibilities between the RM and compliance function Relationship with the valuation function 11% 30% Yes No Informal relationship Formal regular relationship 70% 89% Remaining challenges of the PE/RE industry Coordination between the compliance and risk management function Avoiding redundancies and discrepancies between the two functions Page 9

10 Day-to-Day Risk Management Risk management process Step 1 Identification of risk drivers for the 5 risk categories Step 2 Step 3 Prioritization of risk drivers based on their materiality and probability of occurrence Identification of Key Risk Indicators (KRIs) for every risk driver Set-up To be reviewed annually or on an ad-hoc basis if required Step 4 Set up of risk limits for the identified KRIs Step 5 Step 6 Monitoring of risks and their limits Follow escalation procedures in case of a limit breach Ensure the consistency with the risk profile of the AIF as disclosed to investors On-going monitoring and reporting Page 10

11 Day-to-Day Risk Management Identification & Prioritization of risk drivers and KRI Risk Category Risk Level Risk Driver Probability of occurrence Risk Impact Priority of risk Key Risk Indicator (KRI) Market risk Fund Macro level Moderate Low Low % Change in inflation Asset Micro level Moderate High High % Change in GDP % Change in Unemployment rate % Change in interest rates Counterparty risk Fund Cash at bank Low Medium Low Bank ratings Asset Investors Co-investor risk Transactions Fund manager risk No breaches with regard to AML/KYC Moderate Moderate Moderate Errors in co-investor checks Positive outcome of the transaction due diligence Cases of breach in the SLA with the fund manager Risks that cannot be quantified directly may be measured via proxies. These proxies: must be specific, measurable and timely can then be evaluated relative to benchmarks, or rated using categories (e.g. red / amber / green) Page 11

12 Day-to-Day Risk Management Measuring and monitoring of risks KRI Risk Limit for chosen KRI EWL MNL KRI Value Limit rule Limit Warning (automated) Limit Warning (manual overwrite) % Change in inflation 0.5% 1% 0% If LV > EWL (absolute) = yellow; If LV > MNL (absolute) = red OK OK % Change in GDP -2% -4% -3% If LV > EWL (absolute) = yellow; If LV > MNL (absolute) = red Monitor Closely Escalate % Change in Unemployment rate 2% 3% -2% If LV > EWL (absolute) = yellow; If LV > MNL (absolute) = red OK OK % Change in interest rates 25 bps 50 bps 30 bps If LV > EWL (absolute) = yellow; If LV > MNL (absolute) = red Monitor Closely Monitor Closely EWL: Early Warning Limit MNL: Management Need Limit Automated assessment based on the provided KRI value and the limit rules Risk manager is required to verify the assessment, have a critical view and if required use a manual overwrite XLS Page 12

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