AIFMD Risk Management Services for Private Equity & Real Estate

RISK-BASED GOVERNANCE SOLUTIONS

AIFMD Risk Management Services for Private Equity & Real Estate

Copyright © Arkus Financial Services - 2014 Arkus, your Risk-based Governance Partner Page 2

Risk management for illiquid assets (1/4) Practical overview of AIFMD requirements and challenges our clients face

AIFMD requirements

► Appoint a permanent risk management function functionally and hierarchically separated from the operating units;

► Formalize the risk management framework (including governance structure and policies);

► Implement robust risk management systems (techniques and tools);

► Ensure that the risks associated to each investment position of an AIF and its overall effect on the AIF’s portfolio can be properly identified, measured managed and monitored on an ongoing basis;

► Periodically, at least once a year, review their risk management system. Review the alignment of the investment strategy, liquidity and redemption policy;

► Implement stress tests (including investment ones) and disclose the results of the test to their competent authorities.

Practical challenges our clients face

► Document the independence of the risk management function when

Teams are small;

The risks are intrinsically linked to the investment and management of projects invested in and managed through a structured evaluation and fundamental analysis of each investment opportunity.

► Formalize and document the risk management framework

Formalize RMP, including AIFs risk profile;

Formalize tools to monitor relevant risks and stress test them in a meaningful and proportionate way.

► Report on risk management;

To the AIFM senior management and the board

To investors and the regulator.

Page 2


Risk management for illiquid assets (2/4) How risk management differs for liquid and illiquid assets: in a nutshell

Liquid assets ► In funds investing in assets for which there is an

organized market, the process focuses on:

The active management of the exposure Principally through an ongoing measurement of the

potential downside risk and related internal limits

Illiquid assets

► For funds investing in illiquid assets such as real estate and private equity, for which there are no organized market, the exposures cannot be readily decreased.;

► For such funds the risk management process relies on

Monitoring the occurrence of identified risk events and efficiency of the mitigating factors

Where the resulting criticalities pass over an internal acceptability threshold, further corrective actions need to be implemented

Copyright © Arkus Financial Services - 2014 Arkus, your Risk-based Governance Partner

Operational risks: a key element to understand and report

The criticality concept Vulnerability, risk monitoring and risk rating

Risk management for illiquid assets (3/4)


Other risks, examples and measures

TYPE OF RISK QUALITATIVE LIMIT

IN PLACE?

QUANTITATIVE LIMIT

IN PLACE? COMMENT

Market risk Y Y ► Level of interest rates and of the risk-free rate impact assessment

► Also impact the performance of the target companies, as well as the level of inflation

Credit risk N N

► N/A in the case of non leveraged PE fund at the AIF level and investing only in equity

► However, developments in the credit markets may affect the level of earnings and

cash flow of the target companies, to monitor

Liquidity risk Y N

► For closed-ended PE funds, no liquidity risk on the liability side

► Limited risk on the assets side

► However, the liquidity risk is especially marked at the time of exit and exits must be

adequately planned and the state of the market in terms of liquidity, monitored

closely (analysis of comparable transactions in listed and unlisted structures, multiple

etc. ).

► Investment phase capital calls : risk that an investor will default during a capital call.

Counterparty risk Y Y ► Risk associated with the use of derivative instruments, including hedging instruments

Risk management for illiquid assets (4/4)


How we can help (1/2) “A comprehensive yet modular approach: we have the capacity to support you along the entire risk management process”

AIF’S RISK PROFILING AIFM RMP REVIEW/ DRAFTING

RISK MONITORING RISK REPORTING

► Identification and formalization of all risks inherent to an AIF’s specific strategy by creating a risk hierarchy

► Provide guidance as to how to interpret proportionality

MO

DU

LE

CO

NTE

NT

O

UTP

UT

► Systematized scaling (probability and impact resulting in criticality score)

► Individual AIF risk profile summary

PERMANENT RISK MANAGEMENT FUNCTION

► Draft/ review of existing Risk Management Policy (RMP)

► This include s documenting governance, key risks and KRIs, limits , monitoring and reporting

► Risk dashboard

► Liquidity risk and stress testing reports

► IRR at risk and stress testing

► AIFMD compliant RMP yet meaningful to a specific investment strategy based on a thorough understanding of illiquid assets investment process

► Based on key risks identified , support you implement a practical risk management monitoring tool , including risk dashboard

► Provide you with tailored risk monitoring reports

► Individual risk management sheet

► Board packs risk report

► Regulatory risk reporting Annex 4

► Assist you pull together or prepare for you regular board reporting on risk; alert summaries etc.

► Prepare CSSF regulatory risk reporting compliant with AIFMD Annex 4 reporting template


How we can help (2/2) Sample of our enablers

► Individual RM sheet: Each risk is identified, tracked, reported and managed with appropriate corrective action

► AIFMD-compliant RMP: tailored to the specific investment strategy of the AIFM and each fund managed

► Liquidity monitoring tool

► IRR at risk: used to monitor the risk profile of an AIF in addition to monitoring the criticality score

► Systematic scaling: Although initially subjective, the scaling is assessed in a consistent manner and gradually replaced with actual observations

► Risk profile summary: Internal limits define criticality levels which trigger corrective actions and limit the risk profile


How we add value “Adding-value through risk management activities requires a strong understanding of asset management”

ASSET MANAGEMENT EXPERIENCE

UNIQUE RISK PROFILING & MODELING CAPABILITIES

PRAGMATIC REGULATORY APPROACH

Leverages on their strong understanding and practical experience of asset management to partner with you;

Leverages on practical expertise of senior team members in liquid assets, private equity and real estate

Relies on unique risk profiling and risk modeling capabilities developed over the past 10 years across 3 crises to bring independent insights and meaningful reports;

Is nurtured by our involvement in professional associations, training institutions and close relationships with regulators which enable us to make the link between technical requirements of new regulations and their practical implementation in the real world.

Arkus’ multilingual team of professionals provides a unique combination of:

$


Appendices


Private Equity and Real Estate assets

ID CATEGORY THEME DESCRIPTION RATIONALE INHERENT

PROBABILITY REPUTATIONAL

IMPACT OPERATIONAL

IMPACT LEGAL

IMPACT FINANCIAL

IMPACT CRITICALITY

1.1 Technology risk Reliability & bankability Plant proves not to be working correctly; project is not approved for financing

The technology is not reliable; the track record not strong enough; negative technical due diligence

2 0 4 0 4 8

1.1 Technology risk Reliability & bankability : controls/mitigation factors Technical due diligence; market intelligence; track record 2 0 3 0 2 6

1.1 Technology risk Reliability & bankability : after corrective actions 0 0 0 0 0 0

2.1 Operational risk Localisation/engineering Refusal from local constituencies; reversal of authorizations granted; strikes/blockades

Environmental group may object to the construction of the plant; local authorities reverse a previously granted approval, etc.

1 2 1 0 5 5

2.3 Operational risk Theft/Plant damage Accidental or intentional destruction, vandalism, theft Certain items of the plants (e.g. PV modules) can be removed. Environmental group may object to the construction of the plant, etc.

3 2 2 0 3 9

2.4 Operational risk Fraud risk Risk of fraud over the valuation of underlying asset or the financing of these assets

Risk of financing without real assets to finance/influence on valuation 2 3 1 3 3 6

2.8 Operational risk Grid reliability risk Lack or interruption of grid connection Instable power network nationally or locally; glitches with plant connection to the grid, etc.

2 0 2 0 3 6

2.8 Operational risk Grid reliability risk : controls/mitigation factors Preliminary analysis on grid capabilities; interviews with local grid managers; due diligence on connection points/capacity; etc.

1 0 2 0 2 2

3.1 Regulatory and legal risks Authorisation risk Withdrawal of any authorisations to operate the plant The authorisation process at the time of construction may have been inaccurate or the operation of the plant may not abide by the laws and regulations

2 2 3 0 3 6

4.1 Market risk Financing risk Financing may not be available or terms may be or become costly Financial markets may be instable from time to time 3 0 1 0 2 6

4.1 Market risk Financing risk : controls/mitigation factors Hedging strategies may be implemented. Alternative funding may be available

2 0 1 0 2 4

4.2 Market risk Electricity rates risk Revenues may be negatively impacted by a reduction in electricity rates

Market price of electricity is subject to fluctuations 3 0 0 0 2 6

4.2 Market risk Electricity rates risk : controls/mitigation factors Sale prices for grid-connected plants are relatively inelastic; electricity is normally sold at regulated rates

2 0 0 0 2 4

4.3 Market risk Valuation risk The value of the assets may be reduced The market value of the assets is highly dependent on interest rates and demand for those assets

2 2 0 0 3 6

4.3 Market risk Valuation risk : controls/mitigation factors Interest rates can be fixed and/or risk can be hedged 1 1 0 0 2 2

4.3 Market risk Valuation risk : after corrective actions 0 0 0 0 0 0

4.4 Market risk Leverage risk Increase of losses due to the use of leverage The sub-fund may leverage its capital by borrowing directly at Fund level up to 100% of the Total Commitment of the sub-fund, for investment purposes.

3 0 0 0 3 9

4.4 Market risk Leverage risk : controls/mitigation factors No leverage through derivatives, close monitoring of leverage level

2 0 0 0 2 4

4.4 Market risk Leverage risk : after corrective actions

5.1 Credit risk Counterparty default Exposure to the creditworthiness of its business counterparties Ability to trade and generate revenues is dependent upon contractual arrangements

2 1 0 0 3 6

5.1 Credit risk Counterparty default : after corrective actions 0 0 0 0 0 0

6.1 Liquidity Risk Asset liquidity The value of the assets that can be realised may be materially different from acquisition costs

Assets may not be sold in the expected timeframe and at the expected values

3 0 0 0 3 9

6.1 Liquidity Risk Asset liquidity : controls/mitigation factors Focus on cash flow generation 2 0 0 0 2 4

6.1 Liquidity Risk Asset liquidity : after corrective actions 0 0 0 0 0 0

6.2 Liquidity Risk Liability risk Mismatching asset/liability profile Assets are relatively illiquid while liabilities may have different duration 3 0 0 0 3 9

6.2 Liquidity Risk Liability risk : controls/mitigation factors Focus on cash flow generation; maintain a reserve liquidity; manage overall duration

2 0 0 0 2 4

6.2 Liquidity Risk Liability risk : after corrective actions 0 0 0 0 0 0

Case study - Renewable energy fund

8

9

9

9

9

0

0

0

0 2

2

0

5

6

6

6

6

6

6

6

6

4

4

4

4

4


FUND XYZ Net Asset Value Date: 01/04/2014

AIFMD Risk Reporting


Descriptive Statistics 3

Concentrations 4

Discounted Cash Flow Simulation 5

Stress Tests 6

Liquidity Risk 7

Leverage 9

TABLE OF CONTENTS

AIFMD Risk Reporting – FUND XYZ


Committed Capital 01/04/2014 EUR 10,854,369

Investment Horizon 10 years

Number of Projects 3

Expected Drawdowns EUR 6,090,993

Expected IRR 12%

Leverage 0%

Country Exposure

United Kingdom

Netherlands

Switzerland

Currency Exposure GBP, EUR, CHF

Descriptive Statistics Concentrations Discounted Cash Flow Simulation Stress Tests Liquidity Risk Leverage

Descriptive Statistics

Page 3

e.g. AIFMD Level 2 Regulation – Article 44 (1) Risk Limits

AIFMD Level 2 Regulation – Article 45 (4) Leverage


-EUR 4,000,000.00

-EUR 3,000,000.00

-EUR 2,000,000.00

-EUR 1,000,000.00

EUR 0.00

EUR 1,000,000.00

EUR 2,000,000.00

EUR 3,000,000.00

EUR 4,000,000.00

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

-EUR 4,000,000.00

-EUR 3,000,000.00

-EUR 2,000,000.00

-EUR 1,000,000.00

EUR -

EUR 1,000,000.00

EUR 2,000,000.00

EUR 3,000,000.00

EUR 4,000,000.00

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Expected Cash flow Ladder - CCY Breakdown

Expected Cash flow Ladder - Country Breakdown

Page 4

Data Requirements

- Cash flow projections from Fund Manager

- Relevant project information (FX, country, etc.)


Switzerland United Kingdom Netherlands

GBP CHF EUR

49%

34%

17% Information Technology

Consumer Discretionary

Industry % of NAV

Biotech

AIFMD Level 2 Regulation – Article 44 & 45 Market Risk


(1

0,0

00,

00

0.0

0)

(9

,20

0,0

00

.00

)

(8

,40

0,0

00

.00

)

(7

,60

0,0

00

.00

)

(6

,80

0,0

00

.00

)

(6

,00

0,0

00

.00

)

(5

,20

0,0

00

.00

)

(4

,40

0,0

00

.00

)

(3

,60

0,0

00

.00

)

(2

,80

0,0

00

.00

)

(2

,00

0,0

00

.00

)

(1

,20

0,0

00

.00

)

(4

00,0

00.0

0)

40

0,0

00

.00

1,2

00,

00

0.0

0

2,0

00,

00

0.0

0

2,8

00,

00

0.0

0

3,6

00,

00

0.0

0

4,4

00,

00

0.0

0

5,2

00,

00

0.0

0

6,0

00,

00

0.0

0

6,8

00,

00

0.0

0

7,6

00,

00

0.0

0

8,4

00,

00

0.0

0

9,2

00,

00

0.0

0

10

,000

,000

.00

10

,800

,000

.00

11

,600

,000

.00

12

,400

,000

.00

13

,200

,000

.00

14

,000

,000

.00

14

,800

,000

.00

15

,600

,000

.00

16

,400

,000

.00

17

,200

,000

.00

18

,000

,000

.00

18

,800

,000

.00

19

,600

,000

.00

IRR Distribution PV Distribution

99% PV at Risk: EUR 537,547 99% IRR at Risk: 0.20%

Page 5

Data Requirements

- Cash flow projections from Fund Manager (parameters: min., max., worst 25%, best 25%)

* If no information is available, we have a process in place to estimate the above parameters


99% IRR at Risk: 0.20% 99% PV at Risk: EUR 537,547

AIFMD Level 2 Regulation – Article 44 & 45 Market Risk

e.g. AIFMD Level 2 Regulation – Article 44 (1) Risk Limits



Expected vs. Stressed IRR*

Page 6

-4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00%

* Stress test customisable to your needs

Expected IRR

Extended time horizon to liquidate (+3 years)

Currency of biggest foreign project depreciates 50%

Biggest project fails completely (no cash

flows)

AIFMD Level 2 Regulation – Article 45 (3c) Stress Tests


-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

< 6 months 6 to 12 months 12 to 18 months 18 to 24 months 24 to 30 months 30 to 36 months

Liquidity levels - Asset vs. Liability %

Page 7

Data Requirements

- Relevant investor information from Fund Manager

- Relevant liquidity information from Fund Manager


Lockup period Asset bucket Potential Shortfall

AIFMD Level 2 Regulation – Article 46 & 47 Liquidity Risk


Simulated Probability of Unfunded Commitment

Simulated Worst Case Unfunded Commitment

Page 8


AIFMD Level 2 Regulation – Article 48 Liquidity Stress Tests

0%

2%

4%

6%

8%

10%

12%

14%

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

-EUR 900,000

-EUR 800,000

-EUR 700,000

-EUR 600,000

-EUR 500,000

-EUR 400,000

-EUR 300,000

-EUR 200,000

-EUR 100,000

EUR -

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

The graph shows the largest simulated value which the unfunded commitments can take.



Leverage (Assets/Equity)

0%

50%

100%

150%

200%

250%

300%

Company 1 Company 2 Company 3

Page 9

Data Requirements

- Relevant investment projects data (e.g. accounting data )

AIFMD Level 2 Regulation – Article 45 (4) Leverage details



Should you have any questions…

Date post:	13-Jul-2015
Category:	Economy & Finance
Upload:	arkus-financial-services
View:	562 times
Download:	2 times

AIFMD Risk Management Services for Private Equity & Real Estate

Economy & Finance