Bank credit downgrades mean more frequent reporting reviews, says Carne

Following the downgrade of a number of major global banks, and possibly more to come, fund managers should urgently be addressing their funds’ counterparty risk, warns Carne Global Financial Services.

Many fund managers and treasurers expect a minimum of single A credit status for counterparties, particularly in the derivatives markets. Downgrades mean advisors and managers will have to consider either concentrating more deal flow with fewer names, or revise minimum counterparty credit requirements.

Carne said guidelines set before the 2008 financial crisis may have to be revisited “as there has been a sea change in the global financiallandscape”. The focus on counterparty risk has intensified, with emphasis on CDS spreads and bank credit ratings.

One critical concern is the shrinking pool of A-rated banks which can act as derivative counterparties.

UCITS funds must comply with a minimum credit rating requirement for counterparties to OTC derivative transactions (in the case of firms which are not credit institutions) of A2 or equivalent or an implied A2 rating guaranteed by an A2 rated institution.

For regulated credit institutions this does not apply and therefore will be less of a concern unless a minimum rating is stipulated in the prospectus of the fund.

There are currently no minimum creditworthiness requirements for Cayman fund counterparties. However, they may be covered by the risk management policies of individual fund companies. These policies will require urgent review by fund directors.

According to CESR recommendations, an “adequate” risk management process should be maintained at fund level, and its functioning determined according to the rules established by each investment company. The policy should be reviewed and revised on a regular basis by the board of directors.

The fund’s board should be in a position to review and enforce where required breaches in the risk management policy. In particular, fund directors should be actively engaged in reviewing counterparty risk policies and determining what changes are warranted.

Carne said this is a critical period for fund boards to engage with investment managers to ensure an appropriate policy is in place. It is also a chance for boards to re-visit risk management documentation and operational procedures.

Carne Global Financial Services Limited provides independent fund directors and business advice to the cross-border funds industry, active in London, Dublin, the Cayman Islands, Luxembourg, Switzerland and New York.

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