Best Practice and Gap Analysis Assessments

CMRA is a thought leader in Best Practice. The breadth of our client base, (including hedge funds, money managers, funds of funds, investment banks, commercial banks, derivatives companies, institutional investors) as well as geographic diversity (We have clients on 6 continents) gives us a unique cross industry perspective on best practices.

Selected Assignments in Best Practice

• Review of risk management and risk governance for a large asset manager
• Advised Mutual Fund Directors Forum on "Risk Principles for Fund Directors"
• Expert witness on operational "Best Practices" for CDS
• Evaluated market risk management of structured finance business for large European bank
• CMRA assisted the Mutual Fund Directors Forum in the creation of "Risk Principles for Fund Directors"
• Conducted Risk Governance Survey of 140 financial institutions
• Advised the Buy-Side Risk Managers in the creation of "Risk Practices for Asset Managers", published February 2008.
• Co-chaired the IAFE's Investor Risk Committees Best Practices group
• Conducted a Fund of Funds Best Practice review for The Alternative Investment Management Association (AIMA)
• Conducted a multi-client study on buy-side risk management.
• Benchmarked the practices of hedge funds, money managers, fund of funds, investment banks, commercial banks, derivatives companies and institutional investors
• Served as Technical Advisors and Coordinators to the Risk Standards Working Group in the development and release of the Risk Standards for Institutional Investment Managers and Institutional Investors
• Conducted an Economic Capital survey of 40 financial institutions.
• CMRA has written expert reports and testified on best practices in derivatives, repos, MBS and governance

Publically Disclosed Best Practice Surveys

• Risk Governance 2011
• Risk Governance 2010
• Risk Governance 2009

Recent & Upcoming Speeches re: Best Practices

November 2010

June 2009

Selected CMRA in the Press re: Best Practices

Manager Punished for Failing to Report Error
By Scott Johnson

Consulting firm Wurts & Associates is recommending its clients immediately terminate AXA Rosenberg across all of the firm's products, after the equity manager waited six months to disclose a serious glitch in its quantitative investment process. Wurts says the firm has still not offered a satisfactory explanation.

The situation is "quite an unusual occurrence" in the asset management space, says Peter Niculescu, a partner with New York-based Capital Market Risk Advisors, which provides risk advisory services to pensions, law firms and financial institutions.

"It's impossible for an outsider to assess how serious the issue is because we don't have the facts as to what the quantitative implications are," he says. "All that we really know is that AXA is according the issue due gravity. Given the elapsed time, that seems like it's appropriate."
(April 2010)

Navigating Post-Crisis Dynamics

Directors duty at the brink of insolvency, the importance of liquidity, the shortfalls of GAAP

The capital markets presented public company board directors with a variety of vexing issues in 2009. Leslie Rahl, founder, Capital Market Risk Advisors, suggested that the "next great front" for financial firms and banks, in particular, "is for boards to figure out what its risk appetite and risk attitude is and how to communicate that to management."

"Ask the real simple questions: what could go wrong?" suggested Rahl.
(February/March 2010)

Opalesque Exclusive: Chief risk officers-the newest new hedge fund thing
Kristin M. Fox

The autumn of 2008 well may go down as The Great Fall of the financial system, as the broadmarket indexes and three storied U.S. financial institutions collapsed and the masterminds of previously unfathomable Ponzi schemes, Bernard Madoff and Alan Stanford, were exposed for lining their own pockets with billions of dollars of other people's money.

"The role of the Chief Risk Officer varies from fund to fund," says Leslie Rahl, founder and managing partner at Capital Markets Risk Advisors, a New York-based risk advisory and consultant. "At its best, a CRO wears both strategic and control hats, but in some funds it is primarily a 'cop' role, while at others it is a marketing role. It is impossible to make money without taking risk and risk is not a four-letter word. Only unintended risk-risk that is not understood and undertaken without a reasonable chance of reward-is a problem. The most effective CROs think strategically about how to allocate the firm's scare risk appetite, as well as ensure that risk is diversified within limits and well understood. A CRO also worries about what could go wrong and the least likely events and whether the fund could withstand them, leaving the portfolio manager to focus on the more likely outcomes. You need both perspectives," says Ms. Rahl.
(November 2009)

Risk Governance Survey Shows Troubling Lack of Board-CRO Communication
By Julie Goodman

A new risk governance survey polling asset managers and banks indicates that 28% of chief risk officers never have executive sessions with their boards and that only 60% of boards approve risk policies.

The survey, conducted by Capital Market Risk Advisors (CMRA) and Professional Risk Managers' International Association (PRMIA), looked at the risk governance practices of banks, insurance companies, asset managers, hedge funds and institutional investors from 26 countries.

It was conducted over a two-week period in July, with input from 121 financial institutions. Of the respondents, 25% are asset managers, most of whom have mutual funds.

A number of fund boards have focused lately on strengthening risk management and opening communication channels between risk staff members and boards, and in some cases, they have appointed chief risk officers (CROs).

But while the survey suggests promising trends according to risk management advocates, it reveals some areas of deficiencies for corporate and fund boards.

It found that 85% of financial institutions have a chief risk officer, but 25% of those individuals are limited to a control role, as opposed to a more strategic one.

The survey says the CRO's "regular and unfettered access" to boards is still evolving, with 44% of respondents with a board and a CRO holding executive sessions at most meetings. It also says 11% have executive sessions only once a year, while 28% never hold such sessions.

"I think that risk is a little scary still to a lot of boards, and therefore the comfort level of dealing directly with a risk officer might not be there," says Leslie Rahl, founder and managing partner of CMRA.

The analysis corporate and fund boards receive also was covered by the survey. The results show that only 48% of boards receive trend analysis, and only 42% receive exception reports.

Rahl, a member of a bank board, says those trend and exception reports are extremely valuable for boards.

"It's very, very difficult when you pop in a month or six weeks after the last meeting and someone gives you a snapshot," she says. "I always advise my clients to put their risk reports into a context and provide a trend analysis."
(August 2009)

Hedge Funds Review

Concern Over Regulation is One of the Top Risks for 2009

The top three concerns of chief risk officers for the second half of 2009 are credit losses, volatility and the possibility of governments changing the rules. In the US the main concerns centre on the introduction of followed by inflation and credit.

These were some of the findings contained in a risk governance survey benchmarking risk governance practices of banks, insurance companies, asset managers, hedge funds and institutional investors. The survey was carried out by the Professional Risk Managers' International Association (PRMIA) and Capital Market Risk Advisors (CMRA).

The survey found that hedge fund boards are less likely than the boards of other types of financial institutions to have executive sessions with the chief risk officer (CRO). Under a fifth (14%) of hedge funds and funds of hedge funds (FoHFs) respondents only have an executive session once a year while 29% said they never have one.

Only 43% of hedge funds report on credit risk to their boards noted the survey. However, although only a small number (14%) of institutional investors currently have a board risk committee while 21% plan to create one. Almost half of institutional investors responding to the survey (47%) said they have a CRO.

Over a quarter (27%) of institutional investors currently have a risk appetite statement and an additional 13% plan to create one. Only 27% of institutional investor boards receive trend analysis and a fifth receive exception reports.

The survey was based on results from 121 participants from 26 countries.

Across all respondent types, there was wide agreement on the need for a CRO but influence on strategy compared with control varies. Almost a quarter (70%) of respondents have a CRO, and 15% have someone with a different title but an equivalent function. A quarter said their CROs have a control role only.

The importance of the CRO having regular and unfettered access to the board is still evolving.

CMRA is a financial advisory firm providing risk management advisory and litigation support services to institutional investors, hedge funds, funds of funds, mutual funds, investment and commercial banks, insurance companies and other market participants.
(July 2009)

47% of Funds Have Chief Risk Officer, Survey Says
By Barry B. Burr

Only 47% of pension funds, endowments, foundations and sovereign wealth funds have a chief risk officer, according to a survey of risk governance practices at financial institutions worldwide.

Also, 27% of these four fund sponsor types have a "risk-appetite statement," defining the variability of results they want to take, while 13% plan to create one, according to the survey by Professional Risk Managers' International Association and Capital Market Risk Advisors.

Among the fund sponsors, 14% have a risk committee of their board, while 21% plan to create one.

The survey of 121 financial institutions also included traditional investment managers, hedge funds, investment banks and insurance companies.

When all responding financial institutions were included, 85% have a chief risk officer or a similar position.

The survey, the first of its kind by the two organizations, looks at risk from the financial institutions' governance or board point of view, said Leslie Rahl, CMRA founder and managing partner.

"Formal risk appetite statements haven't fully caught on with institutional investors," Ms. Rahl said, calling the documents "a valuable tool for the board to communicated risk appetite with management."
(July 2009)

Survey: Few measure counterparty risk Leverage, liquidity measurements also seen as lacking

Most pension funds do not measure counterparty risk, six months after the collapse of Lehman Brothers Holdings Inc., a survey by Pensions & Investments and Capital Market Risk Advisors shows.

The P&I/CMRA survey found that pension funds appear to be lacking in two other crucial risk areas: measurement of liquidity and leverage. About half of respondents said they do not measure leverage or liquidity in funds in which they invest. Given the collapse of the global financial system and the steep decline of capital markets over the past nearly 19 months, however, this lack of oversight and monitoring is going to change. The problem is, it's not like flipping a switch: Pension executives are going to have to either open up their wallets or simplify their asset allocations and eliminate exotic investments.

The survey was split into two parts: one for pension executives and one for plan board members or trustees. Roughly 40 people responded to each question on the survey.

The survey of pension executives and trustees found that 70% of respondents do not gauge counterparty risk for the overall pension fund. Counterparty risk, also known as default risk, is the possibility that one party to a trade will fail to meet its contractual obligations.

The results were "startling but not surprising," said Leslie Rahl, president of New York-based Capital Market Risk Advisors. "It's a rather important finding when you consider that managing and measuring counterparty risk began to be raised in 1999" after the 1998 failure of Long Term Capital Management.

In addition, the disintegration last September of Lehman Brothers left money managers, pension funds, custodians and banks holding the proverbial bag, with hundreds if not thousands of trades unsettled. That should have pushed the issue of counterparty risk squarely to the top of investment committee agendas.

Ms. Rahl said even though more pension funds measure liquidity risk than counterparty risk, "that's something that should be moved up the priority scale" as well.

Overall, too few pension fund executives and trustees are fully plugged into their plan's risk management process and simply receive risk reports mostly on a quarterly basis, according to the survey.

"The main conclusion that I drew is that pension funds want and need more," she said. "There seems to be a general understanding that what they're getting is not sufficient."

In fact, while the majority of pension board respondents (58%) receive quarterly risk reports, 39% plan to increase the frequency of risk reporting.

"Clearly at the board level, they're crying out for information on a more frequent basis," Ms. Rahl said. She added that the results largely confirm what pension fund executives have told her.

The P&I/CMRA survey, however, found that on average, respondents spent just $150,000 on risk management in 2008, with the maximum of $500,000. They planned to increase that amount by an average of 20% in 2009.

In a related finding, respondents on average had 1.4 people assigned to risk management, with a maximum of 12. Only 10% of respondents said they planned to add more risk management staff."If you can't either outsource some of it or invest in doing some of it yourself, simplify your life and simplify your portfolio,"

Ms. Rahl said, suggesting that simplifying a portfolio meant taking a close look at asset allocation and possibly eliminating esoteric investments. "I believe very strongly that if you don't understand it, don't buy it."

Separately, some pension funds are planning to implement risk budgeting, according to the P&I/CMRA survey. Currently, just 24% of respondents use risk budgeting, but another 12% said they planned to do so.

"That 50% increase caught my eye," Ms. Rahl said. "There's generally a fairly high correlation" between planning something and doing it. "If someone says they plan to, that generally means it's on the agenda."

With most pension funds still weak on risk management, the big unanswered question is: Will the credit crisis and ensuing drop in capital markets and global recession finally kick pension boards and executives into action?

"This is the event," Ms Rahl said. "My phone's been ringing off the hook."
(April 2009)

VaR Enough?
Market turbulence tests the limits of Value at Risk
By Irwin Speizer

When an investment bank that is supposed to know better loses billions of dollars betting on subprime mortgages, you have to wonder what happened to the concept of risk management. "You can't rely on VaR as your only metric," says Leslie Rahl, president and founder of New York–based Capital Market Risk Advisors. "We recommend people use three to five different metrics. It's like a doctor ordering an X ray, an MRI and a CAT scan — they all tell you slightly different things."

A veteran of 35 years in the financial industry and a financial engineering pioneer, Rahl ran the derivatives business at Citibank in the 1980s before establishing her consulting firm in 1991. She preaches the importance of rigorous risk analysis and testing to cope with the impact of the types of investments she peddled in her earlier role.

Rahl recommends applying stress tests to see how a portfolio would react to sharp drops, market shifts, unusual situations or changes in underlying assumptions. Stress-testing models, which are included in risk systems, can reveal weaknesses that a simple VaR test misses. But Rahl says too many financial firms continue to rely mostly on VaR. Back in April 2000, Rahl's firm conducted a survey of risk practices and found that 45 percent of financial firms, including hedge funds, were not using stress tests at all. Although she hasn't updated the survey, she says she has noticed only a slight improvement since then.

"In risk management only about a third is quantitative," Rahl says. "A third is still a big part of the puzzle, so it is quite valuable." The remaining two thirds of the puzzle is where good risk managers earn their money. Ultimately, an accurate forecast depends on knowledge, experience and chutzpah.

"It has nothing to do with the computer," Rahl says. "It has to do with wisdom and experience."

And perhaps a bit of luck.
(June 2008)

Global Investment Technology
Buy-Side Group Outlines Risk Management Best Practices

NEW YORK - Governance, investment and operations personnel in the securities and investments industry will have all to adhere to certain principles to best manage risk, according to the Buy Side Risk Managers Forum and Capital Market Risk Advisors (CMRA), a consultancy.

The forum, a group of heads of risk managements and chief risk officers from traditional buy-side asset and investment management firms, recently issued a set of risk principles within each of these three areas, titled "Risk Principles for Asset Managers."

"This piece is an important update, "says Leslie Rahl, President of the consultancy CMRA and a member of the forum. "Risk management is a journey not a destination. It's something that keeps going and keeps needing updates."

Governance risk principles concern organizational structure and oversight mechanisms, including the importance of independent controls, segregation of functions, senior management involvement in risk management and oversight and adoption of appropriate policies and procedures.

Investment risk principles relate to the need for risk controls at the portfolio level, and address market risk, liquidity risk, leverage, valuations and other aspects.

Operational risk principles concern risk occurring in the ordinary course of business and in disasters. These address identifying, assessing and monitoring such risks, setting up adequate systems and minimizing manual processes, managing counterparty credit risk and assuring business continuity in a disaster.

"These principles recognize the broader function for risk management, which is not just computing the numbers and tracking the limits, but the proactive functions that help firms optimize the relationship between risk and rewards," says Rahl. "The emphasis on governance has evolved. The focus on governance is clearly something that the regulators are looking for and where the industry is evolving. The principles should provide an important framework for best practice risk management. The discussion of risk governance and valuation are particularly critical in today's market environment."
(March 17, 2008)

Risk Management Decoded
By Liz Peek

"Risk management" has a nice ring to it. Not only does it suggest that a hedge fund team, for instance, has pretty much thought of all the things that could go wrong — it has also, bless its heart, managed those nasty surprises.

Leslie Rahl, founder and president of Capital Market Risk Advisors and a board member of Fannie Mae, has an excellent perch from which to view the unfolding of this latest debacle. According to her Web site, her company is "the preeminent financial advisory firm specializing in risk management, hedge funds, financial forensics, and risk governance."

Ms. Rahl graduated both from the Massachusetts Institute of Technology and its Sloan School of Management and was formerly head of Citibank's derivatives group. She actually understands all those complex formulas that are supposed to identify risk. Numbers are to Ms. Rahl as Cheerios are to the rest of us: uncomplicated and easily consumed.

Her take? "Risk management is all about thinking about two or three standard deviations from the mean. No one ever expects events to fall beyond that. Once in a lifetime events that fall outside that parameter have exponential, not arithmetic, consequences. Risk management is built around models, and models are built around assumptions. The models will work if things behave the way you model them to — but they never actually do. These events are somewhat expected, but we keep forgetting. You can't expect a computer model to anticipate changes. This is the big flaw — I keep reminding clients of this — that their assumptions are not the worst case."

"By definition, most risk people are young quants," Ms. Rahl said. Most, she said, do not carry their modeling back far enough to include similar events, such as the 1994 bankruptcy of Orange County, which she views as somewhat analogous to today's situation. "In 1994, the money funds broke the buck," Ms. Rahl said, referring to the unthinkable: a money market fund that experiences such credit issues with its portfolio that it no longer trades at a dollar. A similar deterioration in shortterm instruments occurred over the past two months, as a few money market funds got into trouble. The credit problems in the early 1990s stemmed from holdings of "inverse floaters" and the "kitchen sinks" — the names given to the leftovers of collateralized mortgage obligations after they had been sliced and diced and the higher-grade parts of the securities had been bought by savvier investors.

At the end of the day, we are reminded of the peril of investing in instruments so complicated that few could really understand them. "Even for me, who loves complex things, it's very complicated," Ms. Rahl said. That's all we had to know.
(September 13, 2007)

Hidden risk: Investors skim over question of fund valuation
By Christine Williamson

"With so much money rushing into hedge funds, people are very anxious about preserving capacity and that's when they begin to cut corners, when it becomes more of a seller's market. But it's the fiduciary responsibility of (institutional) investors to make sure that their fund-of-funds managers are asking all of the right questions about the process of due diligence and portfolio construction, including valuation. It's a bad assumption to think that all fund-of-funds companies are conducting the right level of analysis on the hedge funds they use," said Leslie Rahl, president and chief executive officer of Capital Market Risk Advisors LLC, New York, a hedge fund risk analysis firm and consultant.

"There is enormous interest in this area, but there is still a lot of education to be done of both investors and managers," said CMRA's Ms. Rahl. ``There are a lot of nuances that people are not fully comprehending. Questions have to be very carefully tailored for each kind of strategy. Valuation is an issue any time you have an instrument that's not traded in a transparent, liquid market. Intelligent, well-meaning people will often price the same securities very differently."

The Investor Risk Committee of the International Association of Financial Engineers, Washington, for example, released a white paper on hedge fund portfolio valuation recommendations in early June. Ms. Rahl has served on the IAFE committee that worked on the recommendations for the past two years and co-chaired it last year.
(July 12, 2004)

AIMA Releases Fund of Funds Guidebook
By Susan L. Barreto

The Alternative Investment Management Association Ltd. has released the results of the research on hedge fund of funds it commissioned in 2001, complete with commentary from practitioners.

A 96-page book, "A Guide to Fund of Hedge Funds Management and Investment," covers a broad range of topics including risk management, transparency, hedge fund selection and benchmarking, liquidity, fees and due diligence.

Capital Market Risk Advisors, New York conducted the research, parts of which have been released throughout the year. CMRA coordinated and co-edited the guide that includes three comprehensive surveys of institutional investors, hedge funds and hedge funds of funds completed in the last year.
(October 21, 2002)

IRC Surveys Industry on Transparency and Valuation Practices
By Susan L. Barreto, Senior Reporter

Members of the International Association of Financial Engineers' Investor Risk Committee are conducting surveys in preparation for a January meeting with regulators, the results of which will be discussed at its upcoming meeting.

At the meeting, officials plan to discuss the results of the survey and the first draft of the reporting requirements for hedge funds as divided up by strategy, said Leslie Rahl, who is the U.S. chair of the IRC.
(November 25, 2002)

Preliminary findings from a study of funds of funds by Capital Market Risk Advisors (CMRA) in conjunction with the Alternative Investment Management Association show that institutional investors are still nervous about the lack of transparency and the high risk involved in investing. The study's early findings also show that fund managers and fund of fund managers are hesitant to embrace the idea of best practices or reporting standards. The CMRA study is scheduled for completion and release in August of 2002.

"There is a tug of war going on," said Leslie Rahl, president of CMRA, who shared these preliminary results during a panel on transparency and disclosure at the 9th Annual Hedge Fund Forum held in New York this week. Managers in the alternative investing world are typically anti-bureaucracy and anti-authority, she added. And investors are inclined to demand adherence by managers to "best practices," a full understanding of risk in each fund, and funds with stable infrastructure and investment processes that are not reliant on a single manager.
(June 6, 2002)

Fair value pricing can be fairly unfair: Money managers rely on little price info

What is fair value when it comes to the price of a portfolio?

Scarcely any agreement exists on the issue among mutual funds, hedge funds, funds of funds and traditional money managers, according to a study by Capital Management Risk Advisers Inc. in New York.

More than 60 financial institutions - with combined assets of about $2 trillion - participated in the study.

It's an issue that doesn't get much attention, but it is one that does have an affect on portfolio's returns, says Leslie Rahl, president of Capital Management.

"If you don't even agree on what the portfolio is valued at today, how can you agree on what the risk is that it might lose money tomorrow?" says Ms. Rahl.
(July 30, 2001)