Guernsey: AIFMD Means More Focus On Risk

Last Updated: 22 August 2013
Article by Max Hilton

Most Read Contributor in Guernsey, September 2018

Risk management is critically important in the AIFMD era. Max Hilton of Clarus Risk in Guernsey outlines the issues the industry should be addressing.

One of the key objectives of the AIFMD is investor protection, but targeting the manager rather than the fund brings a number of conceptual and practical issues.

Conceptually regulation of investment managers is not as clear-cut as, for example, regulation of banking where financial strength is unquestionably the overriding concern. AIFMD sets rules on the conduct of investment manager business and the controls over the delegation of key tasks. This is fundamental to the organisational structure of the alternative funds industry and understandably has led to concern and criticism that the directive will reduce the competitiveness of the European funds industry and add additional costs and burden on top of already challenging market conditions.

The financial crisis moved risk management to the forefront of many investors concerns and AIFMD now addresses this in legislation. For many firms, the need to separate the functions of portfolio management and risk management is one of the most troubling aspects of the directive. The 2012 Deloitte 'Alternative Investment Fund Managers Directive Survey' showed that 78% of managers had concerns over the delegation and substance requirements of AIFMD.

While it is common for an alternative fund to have a risk function, the norm, particularly outside the largest and most institutional group of funds is for that risk function to be junior, and to report to the portfolio manager, or 'PM'. Within such funds, the PM tends to have the ultimate control and veto over the portfolio, and controls the relationship with the Prime Broker(s).

In such a structure the risk function tends to be primarily compliance oriented and aims to enforce limits on risk taking. For offshore funds where the PM is onshore and acts as investment adviser, AIFMD presents a massive challenge. Whether the AIFM ends up being the onshore adviser or the offshore fund there is a separate and greater role for risk management as well as for the role for boards responsible for oversight.

1. Veto role

Risk management is a common theme across financial re-regulation but academic literature has long shown

behavioural biases in the investment management industry. PMs tend to increase their risk exposure and trade more following periods of outperformance.

They also tend to trade more following periods of marked underperformance. The roots of this lie in behavioural tendencies as well as in the traditional reward structures for managers. We have included an illustration of performance of a hypothetical long / short USD alternative fund during the eurozone debt crisis between 20th July and 12th August 2011 (see Figure 1). This chart illustrates the timeline and interactionbetween estimates of risk and actual losses. This timeframe is a period when financial markets became 'stressed', measured using a financial turbulence index as of July 28th 2011, six days after Euro zone leaders announced a second bailout package for Greece.

Figure 1.

While the portfolio had suffered large daily losses at the beginning of the period approximately 3%, rather than reduce risk, the PM increased risk exposure. This occurred at a time when loss estimates were increasing, as a function of the market environment.

During this period a number of risk breaches occurred along with an extreme drawdown in performance. If we assume that the limit for daily VaR was a loss of 3%, the portfolio was outside of these boundaries for almost the entire period. The most serious daily loss occurred on 5th August, 11 trading days after the first risk breach and 7 days from the turbulence metric indicating a stressed environment.

The concern for the regulator, investors and the board in situations such as this is who has the ultimate control. In a similar fashion to how a fund board audit committee is responsible for overseeing accounting and financial reporting, a fund risk committee would ensure that the systems are in place to effectively measure and monitor risk such as this as well to demonstrate that the appropriate controls were implemented.

2. Control around mandate

Beyond the prevention of absolute financial loss, AIFMD requires alignment of investment strategy, liquidity profile and redemption policy. Sophisticated investors have long been concerned about 'style drift', to ensure that their basis for allocating to an alternative fund remains intact over time. Prior to the financial crisis it was common for funds to include little in the way of risk parameters around an investment strategy, for example limits on concentration and exposures to certain types of assets and sectors. So long as Prime Brokers were comfortable providing risk capital there was little investors could do in terms of demanding information, or recourse, if the actual investment strategy (and performance) differed to that which they had reasonably expected.

Boards of AIFs will be increasingly concerned with the appropriateness of the mandate and resulting compliance. There is a trade-off to be had between providing enough flexibility for a PM to take advantage of their opportunity set and giving investors suitable comfort that the mandate will be adhered to.

3. Improved performance

The role of risk within investment management does not need to be limited to compliance and minimizing losses. As risk measurement and attribution techniques improve, so do possibilities to mitigate unintended and unnecessary exposures. Currency risk is often one of the largest risks in an international long / short portfolio yet the quantification and management of that risk is rarely considered. Similarly 'size' risk is often significant as managers tend to 'go long' smaller cap, less liquid securities and short more liquid and accessible large cap stocks. Awareness of the magnitude and performance impact of these exposures is the first step. Reducing unwanted and unnecessary exposures should have a positive impact on performance and is a further role for risk management to play. Where the AIFM delegates investment management but retains responsibility for risk management such a framework provides a basis for performance and risk attribution and for oversight of the portfolio manager.

Fall-out from the global financial crisis has brought about a number of improved risk and reporting practices. The market has evolved significantly with investors in alternative funds in a stronger position to demand more detailed and tailored risk parameters. Risk measurement techniques have also improved, with tools to differentiate between normal and stressed regimes to provide more robust risk estimates. AIFMD requirements around risk management however bring new, additional responsibilities to the boards of AIFs, not least because the responsibility for risk management sits with the board. Risk management functions will be tested by their ability to implement policy in an efficient and timely manner during periods of stress. Our case study illustrates that during a market crisis problems can quickly escalate and if the risk function is newly established or in a different geographic location to the PM its ability to implement remedial action and demonstrate control will likely be tested when least expected.

Originally published by Alternative Domicile Intelligence, July 2013.

For more information about Guernsey's finance industry please visit

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions