The calculation and reporting of leverage for liquid alternatives can be misleading for investors, according to speakers at the ALFI Conference in London.
Thomas Nummer of Carne Global Financial Services said that, while it makes sense to offer transparency to investors for leverage, the numbers they are presented with can be unclear, and when only some information is disclosed, it can be misleading.
Disclosing information is a “great idea but very difficult” to get right, he explained.
Another panellist, Michael Derwael of Lombard Odier Funds, agreed that the intention is correct, from a systemic risk perspective. But with different regulations, such as the Alternative Investment Fund Managers Directive and UCITS V, using different definitions of leverage, he agreed that “it’s not always easy to make sense of it”.
With regards to rules around liquidity, the panellists expressed similar concerns. Derwael said: “The regulator is getting things right at least in the description of things.”
He added that while market players have to know their market and the equivalent requirements for their investors, there is no real market consensus. “The intention is good,” he said, but “when you get down to the practical details, it can be quite challenging”.
Nummer suggested that having liquidity risk management as part of an independent risk function in an institution can be helpful, suggesting that reporting to the board is reflecting a more holistic view of liquidity generally. He said: “Flexibility is needed.”
Finally, the panel addressed due diligence processes for liquid alternative products, with moderator Henry Kelly of KellyConsult calling due diligence a “sub-industry” in itself.
One speaker, Manfred Schraepler of Aquila Capital, said: “Due diligence should actually come before anything else.” He specified that this should be considered before targeting investors and getting independent managers on board, and pointed out that it is crucial to understand the product being sold and the target market first.
Brian McMahon of BNY Mellon built on this, suggesting that, with the amount of cash flowing into liquid alternatives, “we need to be a little bit mindful of it.”
McMahon suggested that due diligence should also extend to clients, making sure that they have “the appropriate processes, skills and procedures” in place to be able to manage the product they are being sold.
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