CFTC Roundtable on Risk Management Practices by Commodity Pool Operators
AT TODAY’S COMMODITY FUTURES TRADING COMMISSION (CFTC) public roundtable, Commission staff discussed the risk management practices of commodity pool operators (CPOs).
Session 1 – Direct Investment Funds
Gary Barnett, Director of the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO), asked the panel to give an overview of their governance and business structures. He also asked what types of risks are created by certain business structures and how these risks are addressed.
Tom Lloyd, General Counsel for Campbell and Company, said that risks fall into the categories of: 1) regulatory; 2) operational; 3) counterparty; 4) investment; 5) human capital; and 6) strategic or reputational. He then explained that his firm addresses these risks through the use of an executive committee made up of their chief executives and the heads of each business group.
Steven Felsenthal, General Counsel at Millburn Ridgefield Corp., said his firm also uses an executive committee and stressed the importance of having adequate communication between business lines to identify, address, and mitigate risks. He additionally noted that being registered with different regulatory bodies, including the Securities and Exchange Commission (SEC), leads to overlaps in risk requirements.
Warren Pennington, Principal at Vanguard, said that his firm’s governance reflects the perspectives of their shareholders and is subject to the regulatory requirements of the Investment Company Act and the Investment Advisory Act. He also noted that their mutual funds are subject to certain exemptions under CFTC rules.
Manish Mital, General Counsel of Halcyon Asset Management, stated that the bulk of risk management oversight comes from their investors because they act as their fiduciaries. He then added that his firm focuses on the counterparty risk of the broker dealers they do business with.
Katie Plavan, Head of Investor Relations at MKP Capital, said that her firm separates their business into an investment side and an operational side, and that they have a number of overlapping committees to be aware of the collective risks in the organization. Dov Lando, Chief Compliance Officer (CCO) of MKP, noted that it is important to monitor risks on a daily, monthly, quarterly, and annual basis and that it is important to predict any potential future risks.
Todd Spillane, CCO of Invesco, explained that his firm has a corporate risk management committee which meets quarterly and that each business unit of the organization has its own risk management committee. He said that it is key to analyze investment risk of each portfolio but that the worst risk is “headline risk” because “perception is reality.”
Nicole Tortarolo, Head of Investment Structuring at UBS Alternative and Quantitative Investments (AQI), said that her firm’s management review committee meets monthly and noted that risk control and compliance are structured in the organization’s corporate line rather than in their business line. James Nicholas, Head of Operational Due Diligence at UBS AQI, said that his firm’s due diligence and risk teams look at funds in a “top down” and “bottom up” way to assess their liquidity profiles. He also noted that his group looks at how a fund is structured in terms of its staff, trades process, valuations, cash controls, leverage, and counterparty financing, among others.
Greg Robbins, Chief Operating Officer (COO) at Mesirow Advanced Strategies, Inc., stated that his firm’s business structure creates incentive alignment between managers and investors because they are required to invest part of their income back into the holding company or funds owned by Mesirow. He also noted that his firm has a risk reporting dashboard to track risks. Emma Rodriguez-Ayala, General Counsel of Mesirow, said that it is difficult to think of the industry as a uniform place because organizations have many different investment strategies across a range of asset classes.
Barnett asked the panel what can be done “at the bottom” to manage risk and how information can be filtered to be understandable as it flows to the top where a decision is made. A panelist replied that traders should monitor the news for any potential risks to the markets and that it is important to have the risk monitoring occur on a daily basis. Another panelist agreed that, at a high level, the executive committee should be thinking about risk tolerances but that the job of identifying and monitoring risks should be done by the “people in the trenches.”
Barnett then asked how materiality determinations are made in monitoring risks and how decisions are communicated and implemented. One panelist said that the materiality process depends on the category and who is addressing the risk, but that generally they will assess the potential impact and probability of a risk occurring before reporting it up to the executive committee. Another panelist said that funds produce “statements of control” and often set out control processes from the beginning of an investment. A panelist also noted that due diligence questionnaires are getting lengthier and more specific, and that firms seek to automate as many risk management processes as possible.
Spillane stated that it is important for firms to “create the right culture internally where it is safe to raise an issue” and that if this environment does not exist, “the risk profile goes up dramatically.”
Panelists also agreed that hiring the right people is important to engrain a culture of compliance and noted that larger organizations tend to have more policy driven compliance programs.
A number of panelists noted that CPOs are subject to reviews and exams from the SEC and the National Futures Association (NFA), and submit various business documents that help to capture risk control processes.
One panelist stated that you “can’t regulate fraud” and that there has to be some level of self-policing in the industry to deter bad actors.
Barnett then asked what is done to address situations where inconsistencies or violations of risk management controls occur. One panelist said that forensic testing is done on every policy of the organization and that, if needed, outside counsel will be hired to resolve any issues. A second panelist noted that any violation of policy would be a management issue, rather than compliance, as they have the ability to hire and fire. A third member of the panel said that errors are discovered through either self-reporting of an issue or through “top down” oversight, adding that the firm encourages self-reporting so that they can address any problems quickly.
The panel agreed that a principles-based approach to risk controls that allows a firm to tailor their processes to their unique business is the right approach.
Session 2 – Fund of Funds
In the second session, Barnett asked the panel how the risk management processes of fund of funds differs from those of direct investment funds. A panelist explained that the difference between these two kinds of funds is that fund of funds are one step removed from the assets and often get position and final return data on a one month delay basis. He said that “looking in the rearview mirror” makes it difficult to make real-time decisions. Another member said that independent administrators have become more important and his firm relies on their controls.
One panelist said there are ongoing dialogues with fund managers and that issues can be raised in these discussions if there is any “manager style drift” where the expectations of the investor are no longer being met. Another panelist added that her firm uses a benchmark set by a fund manager in the beginning to make performance comparisons, rather than using position level information.
Barnett then asked how these differences translate to their investor base and if they need more education on the differences. A panelist replied that his firm works with customers to understand their desired level of risk and may create new products that adhere to any guidelines they may have.
Another panelist added that there is a balance for trading companies of providing transparent information to their clients while still protecting their intellectual property.
Barnett then asked if firms need to have information walls up between their fund management and the rest of their business lines. One panelist explained that his firm has a “total information barrier” and that their fund data is kept completely separate from the rest of the company.
Session 3 – Comparing Experiences; Best Practices
Barnett began the final session by asking if there is a negative impact on investors from market participants who do not employ good risk management processes. He also asked if there are issues with costs and barriers to entry or freedom to innovate. Plavan replied that firms which seek to grow and evolve will be driven to implement proper risk management practices in order to gain credibility and stature.
Lando added that there are already processes in the industry that have established best practices, such as NFA and SEC exams, and that these procedures have accomplished what a best practices model would set up. He added that barriers to entry are higher now than they have ever been.
Barnett then asked if there will be movement of risk to less regulated market players since the new regulatory environment, including the Volcker Rule and the Basel accords, may cause banks to shed some of their assets. A panelist replied that the market will react and adapt if these assets are shed, but that it will be difficult for firms which are not risk focused to get into the market. Another panel member said there is a danger that as banks shrink their assets, the number of liquidity sources will decline and bid-offer spreads will widen, pushing up costs.
A panelist said that regulatory action should not prevent market participants from negotiating contracts the way they want to and that adding more layers of rules and procedures would stymie innovation. He then said that the collateralized loan obligation (CLO) market has dried up in Europe due to new rules, and that rules creating friction to new issuances is having a negative impact on the corporate lending markets.
Barnett then asked the panel what would happen is risk based deposit premiums were used in place of the Volcker Rule and if reps and warranties were used instead of risk retention on assets.
Mital replied that banks only put together portfolios and do not underwrite them, and that there are many risk management tools that allow managers to monitor and enforce rules where appropriate. He added that the current regulatory structure does not account financial innovation and that “imposing false rubrics” of risk management is not addressing the right questions.
Another panelist said that there are some baseline best practices already being used in the industry, such as monitoring counterparty and liquidity risks, but said that specificity of any best practices “is what makes everyone uncomfortable.” Other panelists agreed, saying they “do not see inherent cause for concern to warrant special action” and that “to put us all in one space is not practical.”
In conclusion, the panel stressed that the industry is acting in “a way to keep best practices on a fluid level” and that best practices from a regulator would be counterproductive.
For more information on this roundtable, please click here.
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AT TODAY’S COMMODITY FUTURES TRADING COMMISSION (CFTC) public roundtable, Commission staff discussed the risk management practices of commodity pool operators (CPOs).
Session 1 – Direct Investment Funds
Gary Barnett, Director of the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO), asked the panel to give an overview of their governance and business structures. He also asked what types of risks are created by certain business structures and how these risks are addressed.
Tom Lloyd, General Counsel for Campbell and Company, said that risks fall into the categories of: 1) regulatory; 2) operational; 3) counterparty; 4) investment; 5) human capital; and 6) strategic or reputational. He then explained that his firm addresses these risks through the use of an executive committee made up of their chief executives and the heads of each business group.
Steven Felsenthal, General Counsel at Millburn Ridgefield Corp., said his firm also uses an executive committee and stressed the importance of having adequate communication between business lines to identify, address, and mitigate risks. He additionally noted that being registered with different regulatory bodies, including the Securities and Exchange Commission (SEC), leads to overlaps in risk requirements.
Warren Pennington, Principal at Vanguard, said that his firm’s governance reflects the perspectives of their shareholders and is subject to the regulatory requirements of the Investment Company Act and the Investment Advisory Act. He also noted that their mutual funds are subject to certain exemptions under CFTC rules.
Manish Mital, General Counsel of Halcyon Asset Management, stated that the bulk of risk management oversight comes from their investors because they act as their fiduciaries. He then added that his firm focuses on the counterparty risk of the broker dealers they do business with.
Katie Plavan, Head of Investor Relations at MKP Capital, said that her firm separates their business into an investment side and an operational side, and that they have a number of overlapping committees to be aware of the collective risks in the organization. Dov Lando, Chief Compliance Officer (CCO) of MKP, noted that it is important to monitor risks on a daily, monthly, quarterly, and annual basis and that it is important to predict any potential future risks.
Todd Spillane, CCO of Invesco, explained that his firm has a corporate risk management committee which meets quarterly and that each business unit of the organization has its own risk management committee. He said that it is key to analyze investment risk of each portfolio but that the worst risk is “headline risk” because “perception is reality.”
Nicole Tortarolo, Head of Investment Structuring at UBS Alternative and Quantitative Investments (AQI), said that her firm’s management review committee meets monthly and noted that risk control and compliance are structured in the organization’s corporate line rather than in their business line. James Nicholas, Head of Operational Due Diligence at UBS AQI, said that his firm’s due diligence and risk teams look at funds in a “top down” and “bottom up” way to assess their liquidity profiles. He also noted that his group looks at how a fund is structured in terms of its staff, trades process, valuations, cash controls, leverage, and counterparty financing, among others.
Greg Robbins, Chief Operating Officer (COO) at Mesirow Advanced Strategies, Inc., stated that his firm’s business structure creates incentive alignment between managers and investors because they are required to invest part of their income back into the holding company or funds owned by Mesirow. He also noted that his firm has a risk reporting dashboard to track risks. Emma Rodriguez-Ayala, General Counsel of Mesirow, said that it is difficult to think of the industry as a uniform place because organizations have many different investment strategies across a range of asset classes.
Barnett asked the panel what can be done “at the bottom” to manage risk and how information can be filtered to be understandable as it flows to the top where a decision is made. A panelist replied that traders should monitor the news for any potential risks to the markets and that it is important to have the risk monitoring occur on a daily basis. Another panelist agreed that, at a high level, the executive committee should be thinking about risk tolerances but that the job of identifying and monitoring risks should be done by the “people in the trenches.”
Barnett then asked how materiality determinations are made in monitoring risks and how decisions are communicated and implemented. One panelist said that the materiality process depends on the category and who is addressing the risk, but that generally they will assess the potential impact and probability of a risk occurring before reporting it up to the executive committee. Another panelist said that funds produce “statements of control” and often set out control processes from the beginning of an investment. A panelist also noted that due diligence questionnaires are getting lengthier and more specific, and that firms seek to automate as many risk management processes as possible.
Spillane stated that it is important for firms to “create the right culture internally where it is safe to raise an issue” and that if this environment does not exist, “the risk profile goes up dramatically.”
Panelists also agreed that hiring the right people is important to engrain a culture of compliance and noted that larger organizations tend to have more policy driven compliance programs.
A number of panelists noted that CPOs are subject to reviews and exams from the SEC and the National Futures Association (NFA), and submit various business documents that help to capture risk control processes.
One panelist stated that you “can’t regulate fraud” and that there has to be some level of self-policing in the industry to deter bad actors.
Barnett then asked what is done to address situations where inconsistencies or violations of risk management controls occur. One panelist said that forensic testing is done on every policy of the organization and that, if needed, outside counsel will be hired to resolve any issues. A second panelist noted that any violation of policy would be a management issue, rather than compliance, as they have the ability to hire and fire. A third member of the panel said that errors are discovered through either self-reporting of an issue or through “top down” oversight, adding that the firm encourages self-reporting so that they can address any problems quickly.
The panel agreed that a principles-based approach to risk controls that allows a firm to tailor their processes to their unique business is the right approach.
Session 2 – Fund of Funds
In the second session, Barnett asked the panel how the risk management processes of fund of funds differs from those of direct investment funds. A panelist explained that the difference between these two kinds of funds is that fund of funds are one step removed from the assets and often get position and final return data on a one month delay basis. He said that “looking in the rearview mirror” makes it difficult to make real-time decisions. Another member said that independent administrators have become more important and his firm relies on their controls.
One panelist said there are ongoing dialogues with fund managers and that issues can be raised in these discussions if there is any “manager style drift” where the expectations of the investor are no longer being met. Another panelist added that her firm uses a benchmark set by a fund manager in the beginning to make performance comparisons, rather than using position level information.
Barnett then asked how these differences translate to their investor base and if they need more education on the differences. A panelist replied that his firm works with customers to understand their desired level of risk and may create new products that adhere to any guidelines they may have.
Another panelist added that there is a balance for trading companies of providing transparent information to their clients while still protecting their intellectual property.
Barnett then asked if firms need to have information walls up between their fund management and the rest of their business lines. One panelist explained that his firm has a “total information barrier” and that their fund data is kept completely separate from the rest of the company.
Session 3 – Comparing Experiences; Best Practices
Barnett began the final session by asking if there is a negative impact on investors from market participants who do not employ good risk management processes. He also asked if there are issues with costs and barriers to entry or freedom to innovate. Plavan replied that firms which seek to grow and evolve will be driven to implement proper risk management practices in order to gain credibility and stature.
Lando added that there are already processes in the industry that have established best practices, such as NFA and SEC exams, and that these procedures have accomplished what a best practices model would set up. He added that barriers to entry are higher now than they have ever been.
Barnett then asked if there will be movement of risk to less regulated market players since the new regulatory environment, including the Volcker Rule and the Basel accords, may cause banks to shed some of their assets. A panelist replied that the market will react and adapt if these assets are shed, but that it will be difficult for firms which are not risk focused to get into the market. Another panel member said there is a danger that as banks shrink their assets, the number of liquidity sources will decline and bid-offer spreads will widen, pushing up costs.
A panelist said that regulatory action should not prevent market participants from negotiating contracts the way they want to and that adding more layers of rules and procedures would stymie innovation. He then said that the collateralized loan obligation (CLO) market has dried up in Europe due to new rules, and that rules creating friction to new issuances is having a negative impact on the corporate lending markets.
Barnett then asked the panel what would happen is risk based deposit premiums were used in place of the Volcker Rule and if reps and warranties were used instead of risk retention on assets.
Mital replied that banks only put together portfolios and do not underwrite them, and that there are many risk management tools that allow managers to monitor and enforce rules where appropriate. He added that the current regulatory structure does not account financial innovation and that “imposing false rubrics” of risk management is not addressing the right questions.
Another panelist said that there are some baseline best practices already being used in the industry, such as monitoring counterparty and liquidity risks, but said that specificity of any best practices “is what makes everyone uncomfortable.” Other panelists agreed, saying they “do not see inherent cause for concern to warrant special action” and that “to put us all in one space is not practical.”
In conclusion, the panel stressed that the industry is acting in “a way to keep best practices on a fluid level” and that best practices from a regulator would be counterproductive.
For more information on this roundtable, please click here.