Luxembourg has an outstandingly strong expertise in risk management which has been built up from the 1980s when the first UCITS directive was implemented into national law. Since the adoption of the alternative investment fund managers directive (AIFMD), the industry has experienced a reinforcement of the role of risk management. Alternative investment fund managers (AIFMS) may now consider outsourcing part or all of the risk management operations.
We talk to the chief executive officers of Union Investment Luxembourg, Carne Group, SEB bank, and Société Générale to ask what value risk management is to their operations.
"In a time of rapid global political and economic changes and increasingly complex conditions, strong risk management becomes even more important," says Maria Löwenbrück, CEO of Union Investment Luxembourg, the Luxembourg-based asset manager of Union Investment, part of DZ Bank, one of the biggest banks in Germany.
The company´s risk management control systems identify opportunities and threats at company and fund level that are used to manage relevant risks.
“At the fund level, risk management has to be differentiated for UCITS and Alternative Investment Funds (AIF). For traditional UCITS-structures, we measure and manage market risk, liquidity risk, counterparty and credit risk and fund specific risk factors. Moreover, to take into account the specific risks arising from the illiquid asset classes in which our AIF invest, we primarily assess risks and implement asset-class specific risk management techniques and mitigation measures to manage risk.”
NAVIGATING THE RISK LANDSCAPE
Due to the legal framework that applies to investment companies, complex investment products in particular, such as guaranteed funds, are launched by Union Investment Luxembourg. Besides conducting the risk management for the UI funds in Luxembourg, Union Investment Luxembourg also manages the depository network for the entire Union Investment Group and deals with custody and settlement risks in this context.
“Risk management expertise has been built up in Luxembourg from the first minute with the UCITS adoption and primarily enforced from the Luxembourg regulator, the CSSF, which successively implemented a dynamic and comprehensive regulatory risk management framework,” says Löwenbrück.
“The risk landscape in the asset management sector has become more complex and dynamic over the past years, with increasing use of structured products and derivatives, higher fund volumes and more and more unpredictable financial markets. In the context of rising risks and regulation, the strategic importance of the risk function for our business is increasing considerably. In this regard, we see the biggest opportunity for the Risk Function as a standard setter in Luxembourg to take logical decisions and adapt in a flexible manner to new investment opportunities, market trends, and new regulation.”
THIRD PARTY RISK MANAGEMENT
Risk control is a crucial challenge for fund management under UCITS and AIFM. The third-party management company is a familiar concept originating with UCITS. It has taken its next evolutionary step with AIFMD.
“As an asset manager, you don’t necessarily need to set up a management company in Luxembourg, there are solutions out there in the industry,” points out Steve Bernat, CEO of Carne Group in Luxembourg, a global fund management solutions provider, whose core business is providing third party management company services.
“As an industry, we have dealt with asset managers from around the world for the last three decades, so we do understand the local market nuances, and in line with that, we have built innovative solutions. We provide that additional and independent layer of risk management and control, which allows the asset manager to concentrate on their core business which is managing their portfolio.”
DEVELOPING RISK MANAGEMENT EXPERTISE
Luxembourg is one of the company's main operational hubs, and with more than 120 staff globally, it is now the fastest-growing entity within the group that spans across eight locations. “The beauty about being based in Luxembourg is that no matter what you need and want, there are always people in the industry who have that knowledge and expertise in the marketplace,” says Bernat whose staff have an average expertise of 17 years in the fund's industry.
“If I look at my team in Luxembourg, they have experience dealing with so many asset classes, both liquid and illiquid, developed markets and emerging markets. They have a depth of experience that a lot of other financial hubs don’t have.”
Carne Group has invested heavily in technology and has built its own IT team with senior developers, who have constructed state-of-the-art systems, to deal with the new rules and regulations (such as the implementation of UCITS V, the CSSF Circular 11/512 and AIFMD).
“As the management companies have become more sophisticated in the last five years, the financial regulator also has growing expectations of the management company,” adds Bernat. “We have focused on putting the right technology in place to make those processes efficient, so for example, to be able to focus on exceptions rather than going through all the details every single day.”
SUPPORTING INNOVATION THROUGH REGULATION
Indeed one of Luxembourg´s strengths is innovation in regulation. The country´s legal and regulatory framework for investment funds is highly regarded by the global asset management community and leads the way in investor protection.
“I always have the feeling that Luxembourg is setting the standard for the industry and you can clearly see that other domiciles pretty much follow the standard that Luxembourg is setting, especially in the area of risk management. For example, the regulator insists on semi-annual risk reporting which is not required in other domiciles. That is probably why Luxembourg is so far ahead regarding the expertise it has. Because what we have been doing for several years, other domiciles are only now starting to do.”
THE FUTURE OF BANK RISK MANAGEMENT
Established for more than 120 years in Luxembourg, Société Générale Bank & Trust (SGBT) is the oldest foreign bank in the country. It employs more than 1000 staff and offers highly skilled cross-border banking expertise.
“Risk management is of primary importance to us because we are confronted with all types of risks. It can be currency risks, interest rates, liquidity, Anti-Money-Laundering linked to transactions, reputational or even cyber security risks,” says Véronique de la Bachelerie, CEO, Société Générale Bank & Trust.
The bank is a significant liquidity provider for the whole group. “We have to deal with very low rates due to the quantitative policy of the European Central Bank (ECB). Securities services, commercial banking as well as private banking activities provide a lot of liquidity, in this context we run a margin risk because it is difficult to transfer to clients the negative interest rates on deposits.
"A large part of our transactions are in EUR, but a significant amount is also executed in USD, which also means an additional risk of sanctions in the case our bank would not respect the US regulations on Sanction and Embargo items."
For example, it may happen that we intend to finance companies located in countries that are under specific embargo measures; but also that payment or trade finance operations could involve counterparties or beneficiaries concerned by this kind of measures. The concepts of sanctions and embargo as well as more generally the respect of AML/FT regulations are sometimes complicated and burdensome to be dealt with, it means for instance that we have to monitor all transactions of our private banking and commercial banking clients. Our bank has, especially in accordance with SG Group approach, put in place performant filtering tools of clients’ databases and/or transactions.”
ADDING AN EXTRA LAYER OF SECURITY
Cyber security is fast climbing to the top of the list of issues that the financial risk community has to worry about. Société Générale has made protection against cyberattacks a top strategic priority.
“First, we have to build specific systems to deal with these threats and continuously strengthen our lines of defenses. For example, within the Société Générale Group we have build an internal CERT (Computer Emergency Response Team) which is an operational team in charge of preventing and helping to resolve information security incidents targeting the Group. Second, we must raise awareness about information leaks and external attacks among our employees.
"In their day-to-day operations, our staff can unintentionally give access to “third parties” without being aware of it. It is a specific hurdle as in the same time we must embrace digitalisation and “educate” our employees to new collaborative tools and media with for instance the use of social media (LinkedIn, …) for KYC reasons."
The key question we need to ask ourselves is, what risk are we ready to take to facilitate this transition to the digital world for all our employees. It is a global challenge for the financial industry,” concludes de la Bachelerie.
STRIKING THE RIGHT BALANCE
The Swedish bank, Skandinaviska Enskilda Banken (SEB) started its activities in Luxembourg in the 1970s. It specialises in funds and private banking, providing services for primarily Nordic private and corporate customers and financial institutions with cross-border needs.
“We have a long tradition of also providing risk management services to our customers, and we have been practising risk-reward thinking for many years,” says Erika Lundquist, CEO at SEB Luxembourg.
“Banking is a lot about supporting clients in identifying risks and optimising their exposures. At SEB, we have a good balance between a strong risk culture and very conscious risk-reward thinking in every business case. The Nordic culture is open and transparent. To be successful with risk management I think the key is to stay close to the business, identify and know the risks in your business, follow the regulation and implement controls, monitor and report the risks and have escalation procedures in place. But it's also important to focus on the key risks and not lose yourself in the enormous reporting.”
IMPLEMENTING A WELL DEFINED RISK MANAGEMENT STRATEGY
Now, with a staff of 240 working with cross-border financial services, and a branch in Singapore, Luxembourg has become the centre of excellence for crossborder business within the SEB Group. “Today “risk” is integrated into the business as such, and an important part of the whole process that of course goes for our client business part as well,” adds Lundquist.
“As a CEO, you do notice changes in the amount of time that you spend on risk management duties. I spend more time discussing this in client meetings and board and management meetings, and notably, our clients are also eager to understand the latest regulatory changes,” adds Lundquist.
“Ten years ago, we would invite our clients to business breakfasts to discuss how to manage or optimise a portfolio; today the topic is extended to include new regulations such as MiFIDII, PSD2, GDPR, AIFMD, etc.”
GEOSTRATEGIC RISKS ON THE RISE
Investors can also be prepared to manage geopolitical risk in their portfolios by understanding how risk is priced into investments and anticipating how geopolitical developments are likely to affect the value of these investments.
“We always follow macro events closely to proactively manage the agreements with our customers. We combine all the research that we have in the bank and form a “House view” that we base our recommendations on in our advisory service and our discretionary portfolios.
There is also a lot of focus on the investment advisory process, matching our customers’ financial situations, investment goals and knowledge and experience with an investment profile, supporting us when providing the clients with proper and relevant advice,” adds Lundquist.
THE IMPACT OF BASEL III ON RISK MANAGEMENT
Since the financial crisis, global regulators have grappled with devising mechanisms to reduce the systemic risk posed by the banking system.
The regulations that emerged from the international financial crisis and the fines that were levied in its wake triggered a wave of change in risk functions. Key among the regulations affecting the financing markets is the Basel III regulatory framework designed to strengthen financial institutions by placing guidelines on leverage ratios, capital requirements and liquidity.
“Regulations aiming at limiting systemic risk have long been a part of the industry’s day-to-day business, measuring and reporting risk-weighted capital, liquidity ratios and leverage ratios to mention on a few and making sure we have sufficient capital buffers and real control over counterparty risks.
More formal requirements and monitoring are good ways to sustain and develop the confidence for the industry and its function in society. This also ensures that we have a prudent and stable long-term liquidity situation in our bank,” says Lundquist.
FINANCING SUSTAINABILITY
“Another positive development is a meaningful dialogue across the industry around values, code of conduct and sustainability. The United Nations 17 sustainable development goals to transform our world is an important milestone to concretise necessary actions where everyone needs to do their part. We all have an important role in the development of society and in supporting these goals,” concludes Lundquist.
Credits:
Mike Zenari