Risk Management under UCITS III / IV

Christian Szylar is a Member at Kinetic Partners LLP and heads up Kinetic Partners' risk monitoring solution using sophisticated IT based risk engines to monitor and report on areas such as investment restrictions, liquidity, counterparty risk and VaR. Previously, he was conducting officer of RBS (Luxembourg) SA, a UCITS III Management Company as well as Managing Director of RBS Portfolio Risk Services, based in Luxembourg, where he developed a portfolio of risk management services tailored for asset managers. Christian holds a PhD in Management Science, and specialised in Finance and Corporate Strategy at MIT/Sloan School of Management. Christian is a regular speaker at many industry conferences. In addition he contributes to journals frequently, writing articles for many specialized magazines. Christian also teach in different Master degrees in University of Nancy II and Toulouse.

Introduction xi

Acknowledgements xv

PART I. WHAT YOU HAVE TO KNOW ABOUT UCITS TO UCITS III 1

Chapter 1. UCITS to UCITS III 3

1.1. UCITS primer and market size 3

1.2. UCITS – a success story: from UCITS to UCITS III/IV 8

1.3. Conclusion – focus on risk management 26

Chapter 2. Risk Management History: From Banks to the Asset Management Industry 33

2.1. Insight on risk management 33

2.2. A Brief History of Risk Management 39

2.3. From Risk Management to Value-at-Risk 49

2.4. From Portfolio Theory and Capital Requirements to UCITS 60

Chapter 3. Definition of the Value-at-Risk 63

3.1. VaR calculation models 65

3.2. Monte Carlo simulation 83

3.3. Conclusion 92

PART II. UCITS RISK MANAGEMENT 95

Chapter 4. UCITS III Risk Management Process and Taxonomy of Risks 97

4.1. Risk manager’s role and responsibilities 97

4.2. Taxonomy of risks 98

Chapter 5. Risk Management Organization 103

5.1. Risk standards 104

5.2. Description of the risk management process (RMP) 113

5.3. UCITS risk management process 117

5.4. Disclosure requirements 122

5.5. CSSF 07/308 124

Chapter 6. Financial Derivative Instruments and UCITS 127

6.1. Swap 127

6.2. Contracts for difference 137

6.3. The forward contract 138

6.4. The futures contract 139

6.5. Options 141

6.6. Warrant 143

Chapter 7. Global Exposure and Leverage 145

7.1. Global exposure – overview 145

7.2. Sophisticated and non-sophisticated UCITS: is there a distinction? 148

7.3. Sophisticated and non-sophisticated UCITS: how to assess market risk/global exposure 150

Chapter 8. Stress Testing 163

8.1. Definition and overview of stress testing 163

8.2. Main approaches 166

8.3. Types of scenarios 167

8.4. Stress test scenarios 171

8.5. Scenario management/stress testing with PMS 174

Chapter 9. Backtesting 177

9.1. Overview 177

9.2. Back-testing may also reveal important limitations of VaR 183

9.3. Back testing with PMS 186

Chapter 10. Counterparty and Issuer Risk, Concentration Limits and Appropriate Cover 191

10.1. Counterparty risk 191

10.2. Issuer risk and concentration limits 196

10.3. Appropriate cover in the absence of cash-settlement 196

Chapter 11. Liquidity Risk 199

11.1. Overview 199

11.2. Assessing liquidity constraints 201

11.3. Estimation of portfolio liquidity based on historical market data 201

11.4. LVaR 206

Chapter 12. Other Risk Indicators that can be used in the Risk Management Process 209

12.1. Market risk 209

12.2. Interest rate risk 213

12.3. The case of Greeks for the options 218

12.4. Conclusion 223

Conclusion 225

Appendices 233

Bibliography 265

Index 271