Hedge fund managers are some of the brightest professionals in the investment industry. In many cases, after having worked for other firms there are those that choose to set up their own operation because they have reached the point of no longer wanting to be answerable to anyone. In essence, they are the epitome of entrepreneurs and every day they implement their high-conviction investment ideas in the market.
No hedge fund manager starts up his business wanting to manage a back and middle office – this would be completely nonsensical. Nevertheless, they must be mindful. When it comes specifically to their compliance program it very much pays for the hedge fund entrepreneur to be as shrewd as possible.
Risk Assessment Provide Compliance Program Road-Map
Though most hedge fund managers’ first priority is not compliance, as entrepreneurs they must care about their firm’s risk because it is their livelihood. As such, before they even define how to structure their compliance program, they need to have a risk assessment performed either by an internal person or outsourced entity. Once completed they must take a moment to fully process the information himself. A risk assessments helps a firm understand where their operational gaps lie. Furthermore, it assists in defining the process by which the gap will be closed. Finally, it places a time line on when the gap will be closed. The process is a dynamic one so as the world and the firm changes, the risk assessment must also be updated – we strongly suggest at least on an annual basis.
The appeal of the risk assessment is its ease to understand by all employees. Once the risk assessment has been completed, it should coincide with compliance hiring decisions, namely: Will they hire a person to work internally? If so, will it be a senior, mid-level or junior? How many people? Will they consider to initially begin with a more flexible and professional outsourced compliance solution? Maybe a bit of both?
One Size Does Not Fit All
There is no one way to structure a compliance team and program. Every manager has their own target to grow assets. They should also have a target to grow their compliance program (and other fixed cost areas) in tandem. The hedge fund business can be scaled. Nevertheless, once AUM reach a certain level the firm may define whether to approach their compliance program in a different manner.
Regulators and investors adore risk assessments because they provide granularity as to how the manager has given thought to all parts of his business. Regulators and investors do not expect small to mid-market managers that have all gaps filled. They want to see that all gaps have been identified with a plan on how and when they will be filled. In order to appeal to regulators and investors we recommend to document as much as possible and to be forthcoming with pertinent information. Show the regulator and investor that you care about all aspects of your business, not just the front-end. A sense of pride about all of your operations will go a long way in distinguishing yourself from the crowd. It will put you in the regulators’ good book and position you better when competing to manage capital.
A sound risk assessment should assist a compliance program by assessing the internal controls implemented throughout the investment firm for the purposes of mitigating risk and ensuring ongoing compliance with the regulatory requirements along with the firm’s policies and procedures. Furthermore, it should identify the activities that may pose more risk than others. In so doing, this helps a firm decide whether to accept a certain level of risk or to take the appropriate steps to avoid or reduce. In essence, the risk assessment is an important scorecard for the hedge fund manager by providing the road map towards developing and implementing a compliance program that fully aligns with the hedge fund’s risk appetite.PDF version