2013 Hedge Fund Operational Risk: The Road Ahead Part 1
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2013 Hedge Fund Operational Risk: The Road Ahead
By Kristoffer Houlihan Armilla Partners

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Introduction

Since 2012, the CHFA has been conducting Chief Operating Officer (COO) Roundtables designed to chronicle current issues of interest to the hedge fund community. On February 27th in Newport Beach, CA, CHFA held an invitational Thought Leadership Dinner to discuss hedge fund operational risk and the road ahead. The following is a summary of the highlights of that discussion.

 

Topics discussed:

  • Factors to consider when establishing an operational risk management framework at a hedge fund
  • How to identify key elements of a risk culture
  • Key operational risks that COOs need to address, as it relates to start-up hedge funds
  • How hedge funds can measure, monitor, and assess counter-party risk
  • Emerging market operating risk – specifically what COOs should consider as investors look for alpha opportunities within BRICs

Establishing a Risk Management Framework

 

What are the factors to consider when establishing an operational risk management framework at a hedge fund?

 

Key takeaways:

  • Managers need to be able to identify, assess, monitor, and control operational risks.
  • A fund’s ability to deliver excellent operational risk management starts at the top of the organization.
  • Need to remove silo mentality and move towards enterprise risk management. Small and large managers should aim to integrate operational risk, internal control, internal audit, business continuity, and compliance.
  • Need to establish a process-driven approach for practical management of operational risk.
  • There is increasing regulatory burden that must be addressed by dedicated staff. Investing in excellent operational capabilities does not just make good business sense, it can aid in producing alpha.
  • Learn from your investors. Listening to their concerns regarding other funds and issues they have had should allow managers to build best practices and exceed investor demands.
  • Establish an operational risk charter that the fund adheres to and can point to investors.

Key Elements of Risk Culture

How do we as organizations identify key elements of a risk culture?


Key takeaways:

Everyone agreed that this was part of the fundamental building block of enterprise risk management. “Doing the right thing” versus “Doing whatever it takes”. Our discussions revolved around the need for the culture to be encouraged and pushed from the top levels of the fund.

  • Organizational structure – importance of who reports to whom and how everyone is incentivized.
  • Having a risk manager, team, or officer demonstrates the hedge fund’s approach.
  • How well a manager has documented their internal processes. Does the manager follow industry best practices?
  • Internal and client reporting need to outline risk measures, limits, and stop losses. This helps to reinforce a risk culture.
  • Managers should adopt and implement a risk policy.
  • Communication and openness is the key to establishing a solid risk culture within a fund.

Counter-Party Risk

How can hedge funds measure, monitor, and assess Counter-party risk?

Key takeaways:

Armilla led this discussion. A key challenge for investors is knowing who all their counter-parties are.

Four Key Themes:

  • Risk Measurement
  • Limit Management
  • Netting and collateral management
  • Clearing and settlement management

Suggested framework:

Daily Monitoring by checking:

  • Counterparty external rating
  • Market information (Equity Prices)
  • Insider network

Managers need to do more in recognizing this risk and articulating to their clients how they have built a process to manage this risk.

 

Emerging Market Operating Risks

As investors look for alpha opportunities within the BRICs and elsewhere, what considerations should be taken into account?

Key takeaways:

Operational standards for established managers and emerging managers are the same. Our roundtable confirmed that. Emerging market investors have to spend a greater amount of time educating investors on operational and regulatory considerations that may not have been observed in the US and European experiences.

About Kristoffer Houlihan, CQF:
Kristoffer Houlihan, CQF is Managing Partner, Armilla Partners based in Newport Beach, CA. Before founding Armilla, he was Managing Director and Chief Risk Officer for Bank of New York Mellon’s hedge fund platform. Prior to BNY Mellon, he was a Director in Risk Management for Pacific Alternative Asset Management Company (PAAMCO), a $10 Billion Fund of Hedge Funds. For more information about Armilla Partners, visit http://armillapartners.com.

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