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Investors in hedge funds are also becoming increasingly focused on risk, as evidenced by industry inflows which favour the biggest groups with the most robust infrastructure. Says Mr. Quinn: “Increasingly, investors are asking for more transparency – over the type of securities in the portfolio, which counterparties hold assets, who funds the trades, how they are priced and whether there are any unusual movements.” Citi’s Transparency Report has set new standards in this area.
Compliance risk
A succession of regulatory changes will take effect in Europe and the U.S. from 2013 onwards, while parallel regulations are being introduced in other G20 nations. Global organisations will be caught up on several continents at the same time. There is a genuine danger of overload — and with it reputational risk.
Here are some issues to keep top of mind:
• The interrelated nature of some of the legislation means it is dangerous to view specific regulations in isolation. Natalie Westerbarkey, Director, Client Executive at Citi Transaction Services, highlights one example: “MiFID II impinges on the UCITS rules. Structured UCITS will be classified as complex products under MiFID II, and asset managers will need to comply with new transparency rules in the sales process. If they get that wrong, reputation will be at risk. The problem is that while structured and unstructured UCITS funds are defined in the legislation, there are issues of interpretation that may lead to uncertainty in practice. If in doubt, managers should classify their products as structured.”
• Hopes that the move to central clearing of most OTC derivatives would be further delayed have been dashed. Firms must be ready by the end of this year. That means there is now a pressing need to identify those products they trade that will go to central clearing and put clearing and collateral management capability in place, either internally or externally. Asset managers still looking at their options need a custodian with the flexibility to provide either an end-to- end solution or a modular approach to plug specific gaps.
• Firms active in the U.S. will have to do all the above, but also put a compliance infrastructure, including appropriate compliance policies and procedures, and appropriate risk management practices, in place. There is both a legal and regulatory expectation that this will occur for investment advisers registered with
the Securities and Exchange Commission, says Bruce Treff, Managing Director, Head of U.S. Fund Services, Citi Transaction Services: “You must build a compliance infrastructure, test it and document your compliance. That is only part of it. When the regulators arrive to conduct a compliance examination they will look first at risk management practices. They look to understand what you are doing and match it up against your operations and business model. They want to know you have reasonably covered everything off.”
• The first deadline for compliance with Europe’s AIFMD is now little more than a year away. Hedge funds need to select and onboard a depositary, a process that can take many months. “The reporting requirements also ask more than ever of middle office capabilities. The challenge is to be ready in time. Risk technology is very expensive,” says Mr. Quinn. • The option to sign up to FATCA as a
“participating foreign financial institution’ starts from January next year. “Non-U.S. institutions must get ready operationally, look through their chain of intermediaries and get a full understanding of their client base,” says Ms. Westerbarkey. Many UK-based firms are hoping that under the international cooperation agreement between the UK and the U.S., they will only have to report to the Financial Services Authority. “This is a grey area,” says Ms. Westerbarkey: “A UK-based manager might have investment operations based in Switzerland, which could include a U.S. citizen. Switzerland has not signed up so far. So it would be wise to continue to prepare as if you will have to deal with the US Internal Revenue Service anyway.”
Citi’s risk mitigation solutions
At Citi, we are working actively to mitigate many of these risks through our range of industry-leading solutions, supported by robust contingency measures where appropriate: • Eurozone redenomination: Citi has full
playbooks in place for a Greek exit from the euro under any scenario. They can be activated at a moment’s notice, ensuring the local custody platform is operating correctly, which then feeds up into the global custody platform and on to Citi’s fund services business where, again, we have full playbooks in place to enable us to cut NAVs appropriately, both for our long-only and alternative client base. • Asset segregation: With its largely proprietary
network, Citi is able to segregate assets at the global and local levels and, where possible, at the depositary level too.
• Derivatives clearing/collateral management: As a member of almost every CCP, Citi is the only provider with a tried and tested, end-to- end global solution, from trading to clearing to settlement. Any element can be provided on a modular basis. Our collateral offering, through OpenCollateral, is the market-leading, one-stop collateral management solution.
• Risk and regulatory reporting: Citi’s Middle- Office Monitor is a market-leading portfolio risk reporting service. With a Risk Metrics engine, it provides timely, accurate and highly granular risk reports that can be customized for client reporting. Clients also have intraday access to Citi’s operational workflow, on-the- fly P&L reports and up-to-date status trade processing and break resolution.
At Citi, we continue to invest in product enhancements to help fund clients of all kinds respond to the new demands put upon them by regulatory change. With our market-leading presence in direct clearing and custody and our long experience of the derivatives market, developed both as a leading prime broker and alternative fund services provider, we are ideally equipped to deliver solutions for our fund clients that cut through the complexity of the new environment. ■
For more information contact:
Natalie Westerbarkey t: +44 20 7500 0965 e: [email protected] Bruce Treff t: +1 617 824 1425 e: [email protected]